This may be the most underreported financial story of the last few weeks. If the derivative positions look bad enough the Chinese banks are reserving the right to not honor them.
Reuters – Beijing’s derivative default stance rattles banks
A report that Chinese state-owned companies will be allowed to walk away from loss-making commodity derivative trades provoked anger and dismay among investment bankers on Monday as they feared it may set a damaging precedent.
The State-owned Assets Supervision and Administration Commission, the regulator and nominal shareholder for state-owned enterprises (SOEs), told six foreign banks that SOEs reserved the right to default on contracts, Caijing magazine quoted an unnamed industry source as saying in an article published on Saturday.
While the details of the report could not be confirmed, it was Monday’s hot topic in financial circles from Shanghai to Singapore as commodity marketers feared that companies holding underwater price hedges could simply renege on the deals, costing banks millions of dollars in profit.
Derivatives are contracts that are used like insurance, only they aren’t insurance and they aren’t regulated. Berkshire Hathaway’s Charlie Munger said of derivatives, when you try to reach out and collect the money that’s backing up the derivatives the money vanishes. The Chinese situation is once again proving that.
Note that, as with so many other markets, the size of the derivatives market is much greater than that of the underlying assets. The global derivatives market is actually many bigger than the total world economy. That sort of phony baloney market can do odd things, because by definition the money was never there to begin with.
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