China business as “Oil Derivatives Trading” (Fratzscher, 2006). The

China Aviation Oil Holdings Company (CAOHC), a state-owned
company in Beijing, is the monopoly importer of jet fuel in China. In 1997,
CAOHC posted Mr Chen Jiulin to its new Singapore subsidiary, China Aviation Oil
(CAO), as the Chief Executive Officer (CEO). By 2001, CAO had prepared for its Initial
Public Offering with its prospectus describing its business as “Oil Derivatives
Trading” (Fratzscher, 2006).

The Chinese regulators had prepared an elaborate set of
rules:

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·        
People’s Bank of China’s (China’s central bank’s)
regulations: limit derivative transactions by state companies outside of China
to hedging;

·        
China Securities Regulatory Commission’s
regulations: prohibit speculative derivative trading overseas; and

·        
State Council’s regulations: prohibit any
over-the-counter (OTC) derivatives trading for state companies overseas (Somanathan & Nageswaran,
2015).

CAO had also invested in risk management systems, developed
elaborate value-at-risk models, and established three internal controls with
senior traders having strict limits, a risk control committee, and an internal
auditing department. It has also won awards for its corporate governance, with
Singapore investors honouring it as “one of the most transparent listed
companies”. Its spectacular collapse with over US$550 million in derivative
losses in November 2004 can only compare to the collapse of Barings in 1995 (Fratzscher, 2006).

In 2003, CAO disregarded Chinese regulations and engaged in
OTC derivatives trading of oil futures, taking short positions, which were
highly speculative. It also misrepresented its financial position with
accounting gimmicks which extended loss-making futures contracts to avoid
reporting incurred losses (Somanathan & Nageswaran,
2015).

Chen repeatedly bet the price of oil would fall from US$50
per barrel. When it did not, CAOHC covered CAO’s mounting losses by selling 15%
of the 75% shares it owned in the Singapore operation on 20th
October 2004 to Deutsche Bank (DB) for US$120 million without disclosing the
problem. Consequently, CAO faced penalties for not disclosing the losses to the
public until 30th November 2004 (Becker, 2004).

In an affidavit, Chen disclosed that CAOHC was aware of the
losses 10 days before the sale but did not notify its buyers that CAO was
suffering heavy speculative losses. CAOHC had also assured DB of CAO’s fiscal
health before the transaction. Subsequently, DB resold the block of shares to
more than 50 investors, mostly Asian hedge funds, for US$108 million, resulting
in losses of US$12 million for it (Arnold & Bradsher,
2004).

Chen was held responsible for the losses and was arrested
and charged with 15 offences, including forgery, failure to disclose the
company’s losses, and 10 counts of making false statements. Subsequently, he
was sentenced to four years and three months imprisonment and fined S$330,000
for his pivotal role in the near collapse of CAO (China Daily, 2006).

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