Chinese hedges

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When a state-backed conglomerate starts acting like a hedge fund, no one should be surprised when things end messily. Citic Pacific has blown itself up with some cowboy-style trading on the foreign exchange markets. The steel-to-property conglomerate had leveraged foreign exchange contracts for A$9.4bn, even though its capital expenditure and operating expenses through 2010 amounted to just A$1.6bn. When the Aussie dollar tumbled, the hedges morphed into a potential US$2bn loss.

Every hedge fund must wish it had a sugar daddy such as Citic Group, the Chinese state-owned company that owns 29 per cent of Hong Kong-based Citic Pacific. It came to the rescue with a $1.5bn loan facility but failed to stop Citic Pacific’s share price halving. With potential losses on the unauthorised trades almost treble forecast earnings, the scandal is a comedown for chairman Larry Yung, China’s first “red tycoon”.

Where does Citic Pacific go from here? The company burst on to Hong Kong’s corporate landscape in the 1990s, snapping up big stakes in British-owned assets such as air carrier Cathay Pacific, and is a survivor. The loan, added to its own cash and loans of $1.1bn, should be sufficient to stave off any liquidity problems. But gearing will rise sharply, to about 100 per cent on a net debt/equity basis. The timing is nasty. The hedges exploded as Citic Pacific’s main business lines are wilting. Prices for iron ore and steel are tumbling, and Chinese property looks wobbly.

Trust in a company once revered for its Chinese guanxi, or connections (Rong Yiren, Mr Yung’s father, was vice-president of China in the 1990s) has evaporated. Analysts could not issue sell notices quickly enough on Tuesday. Worse still, it took Citic Pacific six weeks to disclose the situation. During that period, as independent analyst David Webb points out, its shares tanked 42 per cent, underperforming the broader Hong Kong market.

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