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China: SOEs threaten derivatives defaults

A worrying trend has surfaced in emerging markets as volatility hit China’s hedging contracts.

The news that several prominent Chinese state-owned enterprises are considering defaulting on loss-making derivatives contracts is further evidence of the return this year of a depressing emerging markets tradition. Sources at foreign banks active in China tell Euromoney that at least six such banks have received letters from SOEs informing them that the companies reserve the right to revisit derivatives contracts sold them by financial institutions.

The contracts, generally hedging products designed to offset movements in currency or commodity prices, are incurring heavy losses for the companies in question. Companies from the transport sector have been among the worst hit, with one bank source telling Euromoney that state-owned airlines were among those hoping to extract themselves from contracts now losing money thanks to volatility in the oil price.

So far there has been posturing but no action: the SOEs sent the letters to the banks in August but no defaults have been reported yet. The recipients of the letters believe that they were sent under pressure from the Chinese regulators, which are keen to avoid the public perception that China’s state-owned champions are being savaged by foreign banks and their derivatives.

There is also an element of sabre-rattling by the foreign banks.

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