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Citic Reveals $2 Billion FX Loss

Foreign exchange volatility claimed a high profile victim when Citic Pacific, a Hong Kong-based conglomerate, revealed that it had lost $1.9 billion due to “unauthorised” foreign exchange trading. The firm is the Hong Kong arm of China’s government investment agency, which means the losses are an embarrassment to the local authorities.

Investigations are underway into how Leslie Chang, finance director at the firm, could place such large bets without any interference from financial controller Chi Yin Chau. Both men have left the company, local media reports.

The transactions were linked to equipment and materials for an iron-ore mine in Australia and were Dual Currency Target Redemption Forwards and Daily Accrual contracts which sought to take advantage of a continued rise in the Australian dollar. Effectively, the structured products allowed Citic Pacific to buy the weaker of either the Australian dollar or euros at below market rates – in this instance 0.8700 and 1.4400 respectively – against the US dollar, to cheapen the cost of paying for the Australian equipment.

Market sources in Sydney claim that the dramatic falls in the AUD seen over recent weeks, when it fell from above 90 cents to the US dollar to below 70 cents, could be a result of the company trying to protect itself from losses although the company itself denies this, stating it has only “bought and sold AUD forward contracts to manage its exposure”.

The $1.9 billion loss is a valuation at current market rates, according to a source familiar with the transactions. The company is committed to the structured products for “at least another year” – in other words, unless the Australian dollar strengthens considerably, the company’s losses may steepen further.

In a statement Citic says, “The maximum deliverable amount to the Group under all AUD target redemption forward contracts is AUD 9.05 billion and is deliverable in monthly installments up to October 2010. The maximum deliverable amount under the daily accrual contracts for AUD is AUD103.3 million and is deliverable in monthly installments up to September 2009.”

The departure of the two executives, who were allowed to resign by Citic, comes after the firm claims the trades were unauthorised. A market source who claims to have executed at least part of the trades expresses some scepticism over that statement. “The firm must have known because we were sending emails to several people in the firm with the Term Sheet attached,” the source says. “We explained to the firm that it had no downside protection in place, but they weren’t worried by this.”

An Australian-based source says the revelation of large losses is unsurprising – and he expects more. “In July [when the trades were executed] the whole world thought the US dollar was going to continue lower, especially against the Aussie and euro. Just about every analyst was predicting parity in AUD/USD, so it is unsurprising that a corporation believes the one-way bet theory. I wouldn’t be surprised if other companies have fallen foul of the strategy – there may be other, probably lesser, losses revealed in coming weeks.”

There were some early fears within the counterparty banks that the company would try to walk away from its obligations. The trading counterparty source says that discussions early last week were about the bank’s potential exposure if it did so.

“There have been a couple of instances of Asian corporates refusing to fulfill contracts because they were allegedly traded illegally,” the source explains. “Citic is a big company and it is unlikely to have a devastating long term effect on its business, therefore we don’t expect any problem this time.”

On Asia stock markets, Citic’s shares took a pounding and at one stage were more than 66% down on the week. Going forward there could be more problems for the firm’s stock price because, as the Australian-based source says, “The stock price is now inextricably linked to the fortunes of the Aussie – and that means it is in for a rollercoaster ride. We expect the firm to be on top of the market during any decent rally in the AUD/USD.”

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