Professional Documents
Culture Documents
BECG Case - 2
BECG Case - 2
SingaporeInc.'sChallenges
'Theirbusiness
is thejet fuelbusiness...theyshouldhaveconcentratedon that."1
- OngEngTong,an independentoil consultant
'Thereis a saying,if a companyloses $50 million, it's the company's problem. But if it loses $500 million,
it's the system'sproblem."2
- A Singaporeoiltrader
China
AviationOil'sCollapse
China istheworld'ssecondlargestconsumerofjet aviationfuels,andaccordingto anestimateby InternationalEnergy
Agency,jetaviation
fuelimportsaccountfor abouta thirdof China'stotalconsumption,whichisabout230,000barrelsper
day,4China Aviation
OilCorpLtd,establishedin 1993,is a multinationalinvestmentandoilinfrastructurecompanywithits
headquarters inSingaporeandisthesoleimporterofjet aviationfuelin China.Itis majorlyownedby ChinaAviationOil
HoldingCompany (CAOHC)(Exhibit1),astate-ownedenterprise(SOE)thatenjoys100%monopolyin thesupplyofjet
fuels
inChina.CAOCH suppliesjet fuelsto morethan100airportsacrossChinaanditsbusinessisestimatedto beworth
onebillion
dollarsannually,S
In2001,CAOstockswerelistedontheSingaporeExchangeandwereoneofthefavouritesamongtheinvestors.With
thehugeincrease inairtravelvolume,bothdomesticandinternational,Chinabecamea majorbuyerof airlinersand
aviation
fuel.CAO'sbusinesswasprospering,butits incomewassubjectto the highvolatilityin oil prices.Toreducethe
impact
ofoilpricefluctuations
onitsearnings,CAOusedoilsw~psfor hedgingpurposes.In2003,inorderto increaseits
'C se~I ~aderloses 550 milliondoll.. in derivate trading', httpJlbreaking-news.news.designerz.com, December l' 2004
Tailahashl,
Kosuke'Jet fuel scandal deals China a body blow", www.atimes.com. December 7" 2004
'A coIapsethatwavesa 'big red flag' about business with Beijing', Financial nmes. January 21' 2005
, 'CADSubsidiarySeeksJet Fuel Imports For China', http://news.airwise.com, December 13" 2004
Ibid
earnings,itbegantradinginfuturesforpurelyspeculative
reasons.CAO'smanaging directorandChiefExecutive Officer,
ChenJiulin(Chen)wasresponsible forthespeculative
tradingattheSingapore Exchange.Inearly2004,Chenspeculated
thattheoilpricewouldbearound$38perbarrel,inthefourthquarteroftheyear.Hewasexpecting theoilpricestofall.But
inOctober 2004,oilpriceswentskyward. Withoilpricesover$55perbarrel,ithadwellpassedChen'sexpected priceand
helostthebet(Exhibit
2).Accordingtothecontract,CAOhadtopaythebanksandfinancials institutions
theearnest money,
whichwas$5000foronedollarriseinoilpriceperbarrel.
Havingexhausted itsownresources topayforthemargincall,itturnedtoitsparentcompany forfunds.CAOHClent
$108milliontoCAO.Thisamount wasraisedbyselling15%ofitsstakeinCAO,whichreduced theparentcompany's share
from75%to60%.According tomediareports,CAOHCapproached Deutsche Bankforhelpinsellingthestakethrougha
blocktrade.Insuchadeal,aninvestment bankpurchases alargeblockofsharesfromanissuer- thecompany orabig
shareholder - andresellsthesharesata discounttoasmallcadreofprofessional investors.
According toSingapore
regulations,Deutsche Bankwasnotrequired toperformextensive
duediligence onthecompany andrestricted
itselftoa
shortsetofquestions aboutitsfinancialrecordsandwhethertherewereanyissuesthatcouldhaveamaterialadverse
impactonthebusinessor itsfinancialcondition.Onreceivinga favourableresponseDeutscheBanksubmitted the
regulatoryfilingwiththeexchange. Finally,DeutscheBankoffered145millionCAOsharesat S$1.35each,with14%
discounttothemarketprice.Byindustrymeasures, thedealwasasuccess.
Withtheparentcompany'shelp,CAOmanaged tosettlefewofthedeals.But,bylateNovember,CAOhadreceived
paymentdemandsformarginpaymentsandsettlement of derivatives
tradesfromJ Aron,Mitsui& CoEnergyRisk
Management, BarclaysCapital,SouthAfrica'sStandardBank,Sumitomo MitsuiBankingCorporation,
FortisBankand
Australia's
Macquarie
Banktotalling$247.5million(Exhibit
3).6Unabletosecuremorefunds,Chenmadeit knowntothe
publicthathiscompany hadcollapsed with$550millioninderivativelosses.CAOSingapore'sstockpricefellsteadily-
losing39%beforetradingwassuspended onNovember 26111
2004.Chenwasarrestedforhisinvolvementinthecollapse.
Assetsbeinginsufficient
toservicethedebt,creditorsbeganexpecting parentcompany toprovideadditional
resources
tofinancethedebt. Withpressuremounting fromitscreditorsforpaymentsandto avoidbankruptcy, CAOputupa
reorganization plan.According
totheplanCAOHC wouldconvertpartofa$118millionloantoCAOintoequityandinvest
additional$50million.Singaporestateinvestment agencyTemasek HoldingsPIe.Ltd.wouldinvestanother
$50million.But
theinvestment wouldnotproceedunlessthecreditorsaccepttherepayment plan,Le.CAOwouldrepayatotalof$220
milliontoitscreditors,
ofwhichitwouldpay$100millionimmediately andtheremaining $120millionwouldbepaidovera
periodofeightyears.MichaelColeman, managing directorof Singapore-basedAislingAnalyticsPte,said,"It'snota
compelling case,yougottowaiteightyears.Youarenotgettingbackenoughupfronttomakeitworthwaiting."7 Creditors
wouldhavetowriteoff60%ofthemoneytheyloaned.OfficialsfromtheSin,gapore-based Overseas ChineseBanking
Corp.,oneofthecreditors, said,"Theproposed schemeofarrangement isagoodstartingpointforfurthernegotiations
between allthecreditors
andCAO."8 CAOalsoappointed consultantDeloitte&Touche toactasitsfinancial
adviser.Even
thoughthecompany hadmanaged a bailout,itfacedlegalandcriminallawsuitsinSingapore.
Critics
saythattheCAOscandalhadbroughtintospotlight theshortcomings inthecity-state's
financialliberalization
process.Thiswasnotthefirstcorporatescandalto happenattheSingapore Exchange.In November 2004,three
employees fromtheGovernmentofSingapore Investment
Corp,whichmanages Singapore'sforeignreserves, werefined
forinsider
trading
inJapaneseshares.InApril2004,aformerfinancemanager withAsiaPacificBrewerieswasjailedfor42
yearsforcheating GermanandJapanesebanksof $71million.In 2001,Singapore-listed AsiaPulpandPaper,an
Indonesianwood andpulpconglomerate,
defaultedondebtstotalling
$13.9billion.1OThemostinfamous ofallthescandals
was thecollapseoftheUK'sBaringsBankin 1995afterit lost$1.2billiononderivatestradingby'roguetrader'11 Nick
Leeson(Box 1).
Box1
Collapseof BaringsBank
'Wewerealldriventomakeprofits,profits,andmoreprofits..."saysNickLeeson(Leeson)in hisautobiographyRogue
Trader,
Leeson hadshakenthefinancialworldin 1995whenhe single-handedlybroughtdownoneof the oldestand
revered
merchant banksinUK.TheBaringsBankwasbankruptbecauseofunauthorizedtradinglosses.
LeesonhadworkedbrieflyforMorganStanleybeforejoiningBarings.Atbothfirms,heworkedinoperations,butshortly
after
JOining
Barings,
hewastransferredtotheJakarta,whereheeamedanameforhimselfbyhishardwork.So,in 1993,
whenBarings
Securities
(Singapore)Limited(BSS),purchaseda seatfortradinginfuturesontheSingaporeIntemational
MonetaryExchange(SIMEX- today'sSingaporeExchange)the Barings'managementpromotedhimas thegeneral
managerofBarings
Futures(Singapore).
LeesonwasBarings'starSingaporetrader,bringingsubstantialprofitsfromthe
SIMEX andhadmademorethan£1Om- about10%of Barings'totalprofitfor 1993.He himselfhadeameda bonusof
£130,000
onhissalaryof£50,000.
Hisposition
authorizedhimtodotwotypesoftransactions.Transactingfuturesandoptionsordersforclientsorforother
firms
within
theBarings organization,
andarbitragingpricedifferencesbetweenNikkeifutures(Nikkei225)tradedonthe
SIMEX andJapan'sOsakaExchange.Leesonexecuteda tradingstrategyknownas a "straddle,"withtheobjectiveof
makingaprofit
bysellingputandcalloptionsonthesameunderlyingfinancialinstrument.A straddlewillgenerallyproduce
positive
eamings whenmarketsarestablebutcanresultin largelossesifmarketsarevolatile.
Leesontookmassive risksonBarings'financesbecausetherewerehugefinancialincentives.Thelargertheprofitsthe
traders
made,thegreaterweretherewards.But,hewaslosingmoneyandbythe autumnof 1994,thelossesstoodat
£208m. HehadtopaythoselossestoSIMEXintheformof marginandforwhichhe neededcash.Hefalsifiedrecords,
fabricated
letterstodeflectquestionsfrommanagement,auditorsandevenrepresentativesof SIMEXandcontinued
obtaining
cashfromBarings.Hewasableto concealhis unauthorisedtradingactivitiesfor over a yearbecausehe
managed boththetradingandbackofficefunctions.Leesonhadhiddenthelossesin an accountcalledErrorAccount
88888,andwaspubliclyrecordingprofitsinthreearbitragetradingaccounts,numbers92000,98007and98008.This
wasaccomplished throughcross-tradeswithaccount88888.Byperformingfuturestransactionsat off-marketprices,
Leesonwasabletoachieveprofitsinthearbitrageaccountswhileplacingoffsettinglossesintheaccount88888.Leeson
requested
andobtained extrafundstocontinuehistradingactivities,asheattemptedtoextricatehimselffromthefinancial
messbymoreandmorefreneticdeals.Havingbecomeincreasingly desperate,LeesonbetthattheNikkeiindexwouldnot
dropbelow 19,000 points,andthebetseemedreasonablefor,theJapaneseeconomywasrebounding.OntheJanuary
17~,
adevastating earthquake hitJapanandthatcauseda steepdropin theNikkei225index.Leeson'sunauthorized
trading
positions
suffered hugelossesandhisoperationwasunraveled.
Leeson's
trading
hadcreatedliabilitiesworth$1.3billionfor Barings,whichwasmorethantheentirecapitalandreserves
ofthebank.The223-year-oldBaringsbankbecamebankruptandin March1995it was boughtfor £1, by the Dutch
banking
andinsurancegroupING.
Leesonwasarrestedandconvictedof fraudby the Singaporeanauthority.He wassentencedto six anda halfyears
imprisonment
butforgoodbehaviour,hewasreleasedfromprisonearlyinJuly1999.
Thecollapseof CAOhadraisedquestionsonthestandardsofcorporategovemanceinChinesefirmsandhighlighted
the flawsthatare often overlookedin the generalenthusiasmaboutthe country'semergenceas a globaltradingand
economicpower.A majorityoftheChinesecompanieswerestate-ownedenterprisescontrolledbyentrepreneursorfamily
memberswhohadlittleexperienceinlookingafterminorityshareholdersandonlya partialunderstanding ofconceptssuch
asboardindependence, independentauditingof resultsandtheneedforproperriskcontrol.Limiteddisclosureandlackof
transparencyin dealingshadcompoundedthe problemof compliance.There weremediareportsthat the corporate
governanceof Chinesefirms,listedin Singaporeespeciallywasworsethanthoselistedinothercountries.MakYuenTeen,
co-directoroftheCorporateGovernanceCentreattheNationalUniversityof Singapore,arguesfora returntostricterrules
by SingaporeExchangeto avoida raceto the bottom,since"smallerexchangeslike Singafdoremaybe a fourthor fifth
choicefor Chinesecompaniesthatcannotget to theUSor HongKong."14
WithChinesecompaniestumingtoforeignmarketsto raisefunds,it hadalsoraisedan alarmforthecreditorsaboutthe
risksofinvestingin Chinesefirmsespeciallythestate-ownedenterprises.Earlier,creditorswereeagerto lendto Chinese
firmsinthehopeof tappingChina'spotentialastheworld'sfastestgrowingmajoreconomy.Nowthereweredoubtsonthe
abilityof Chinato deliveron the promiseon whichso manybigtimeinvestorshadputtheirtruston, InCAO'scase,25
creditorsstandto lose60%oftheirinvestments(Exhibit4).
Worriedthatthe CAOdebaclemightcauseinvestorsto shunChina-relatedstocks,andinturnaffectthe transaction
volumesattheExchange,theSingaporeExchangemadeknownthat"themarketshouldconsidereachcompany,beitlocal
orforeign,on itsmerits".ISTakingcorrectiveaction,it suspendedthe tradingin CAOstocksanddirectedCAOtoappointa
specialauditor,PricewaterhouseCoopers, toinvestigatethecircumstances thatledtothelosses.ThepolicerunCommercial
AffairsDepartmentinconjunctionwiththecity-state'ssecuritiesandderivativesexchange,theSingaporeExchange,andthe
MonetaryAuthorityof Singaporeinitiatedacriminalinvestigationto lookintothe possibilityof white-collarcrimeat CAO.
Singapore'sgovernmentmadeit clearthatit considersthe investigationintoCAOascrucialfor upholdingthecity-state's
reputationas a financialcentre.Butt~einvestigationwassensitivebecausethe Chinesegovernment- a closetrading
ChinaAviation
OilHolding
Company
(1)
'l/llill
Public ChinaAviation
.l
OilSupply
Company
llIli,. ':fllill
1) ChinaAviationOilHoldingCompany
("CAOHC'1,
astate-owned
enterprise
inthePRC,ownsapproximately
75%of theenlargedsharecapitalofourCompany. According10theprovisionsofthelawofthePeople's
RepublicofChinaonIndustrial
Enterprises OwnedbytheWholePeople,CAOHC's assetsareownedbythe
peopleofthePRC(i.e.theState).TheStateCOuncil
exercises
ownership rightstoCAOHC's assetsonbehaN
oftheState.
2) GreaterChinaTravelIndustry(Singapore)PteLtd wasincorporatedin SingaporeasourCompany's
wholly~wnedsubsidiary./ts
primarybusinessistheprovisionoftravelservices
Source:CorporateStructure,http://caosco.com
Exhibit2
NewYorkMercantile
Exchange(Nymex)Oil FuturesContractfor2004
65
55
)45
CQ
~
35
25
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2004
Source:
Sawyer,
Nick':4 wrong-way bet'~ http://db.riskwaters.com, January 2005
Exhibit3
CAD's PaymentDemandsas of November2!1'2004
Unwinding of50%volumeofeight
IManagement
Mitsui& CoEnergyRisk November
9 70,331,400 derivatives
contracts
l Macquarie
Bank
November19 2,610,000 Margincall
Total 247,518,192.92
Source:
Sawyer,
Nick "A wrong-waybet'~ http://db.riskwaters.com, January 2005
Exhibit4
MainCreditorsof TroubledCAOandTheirinvestments
'S.No Creditors Amountin$, million
1. ChinaAviationOilHoldingCo 118.0
2. SatyaCapitalLtd. 51.7,
3. StandardBankLondonLtd.: 34.1,
4. SumitomoMitsuiBankingCorp. 26.1,
5. Industrial& Commercial
Bankof China(Shanqhai
branch) 26.1,
6. ChinaEverbright Bank 26.1,
7. Bankof Communications (Singapore) 25.9,
8. BPSinqapore Pte.Ltd 23.3,
9. ChinaMerchants BankCo.Ltd. 19.3,
10. BarclaysBankPic. 18.5,
11. BeijingCityCommercialBank 17.4
12. ChinaOil(HK)Corp.Ltd. 16.4,
13. SingaporePetroleum Co.Ltd. 15.4,
14. GlencoreInternational
AG 15.0,
15. Oversea-Chinese BankingCorp.Ltd. 15.0,
16. SKEnerqyAsiaPte.Ltd. 14.3,
17. SocieteGenerale 13.8,
18. Norddeutsche LandesbankGironzentrale 13.0
19. ShanqhaiPudongDevelopment Bank 13.0,
20. ItochuPetroleum Co.(S)Pte.Ltd 12.4
21. Bankof Communications (Shanghai) 10.6
22. UnitedOverseasBankLtd.(Singapore) 9.7,
23. Industrial& Commercial
BankofChina,Macau, 9.7
24. J Aron& Co. 7.7
25. MacquarieBankLtd. 6.1
Source:"FACTBOX-Main
creditorsoftroubledCAOSingapore",www.reuters.com.
January24111
2005