China's state-owned enterprises may unilaterally terminate commodities contracts as they try to cut massive losses from financial derivatives, an industry source told Caijing on August 28.
According to the source, China's State-owned Assets Supervision and Administration Commission (SASAC) has sent notice to six foreign financial institutions informing them that several state-owned enterprise will reserve the right to default on commodities contracts signed with those institutions.
This is of great significance in terms of investment bank earnings in their OTC trades in Hong Kong. It also raises a question as to how well counterparties have "netted" these OTC trades in the underlying commodities.
Foreign brokerages usually work through their Hong Kong operations to sign over-the-counter derivative hedging contracts, according to an investment banker whose firm is involved in the business. Hong Kong and Singapore usually serve as venues for arbitration over such transactions.
Most investment banks may "just swallow" any losses arising from canceled contracts, the executive said, adding that any losses are usually made up for with compensating trades.
Investment banks "just earn less" from such transactions, he said.
But any such move would be a major blow to investment banks which service massive commodities hedging operations for Chinese SOEs on the international market, said the executive.
Regardless of potential losses for participating firms, this is a worrying sign for the transparency and security of doing business in China.