China Aviation Oil’s Collapse: Singapore INC’s Challenges

Case BackgroundChina Aviation Oil(CAO) is a Singapore based company

majorly owned by China Aviation Oil Holding Company(CAOHC)

Enjoys 100% monopoly in supply of jet fuels in China

Listed on the Singapore Exchange in 2001 and was voted as the most transparent

Later lost $550 m in speculative oil trading

The scandal raised concern on the credibility of Singapore

China is 2nd largest consumer of Jet Aviation Fuels.

China imports 1/3rd of the fuel of its total consumption which is 230000 barrels per day.

China Aviation Oil Corp Ltd established in 1993, is a multinational investment and oil infrastructure company.

Sole importer of Jet Aviation fuel in China.

It has it headquarters in Singapore.

China Aviation Oil Holding company has 75% stake in CAO, has 100% monopoly in supply of jet fuels in China.

China Aviation Oil’s Collapse

Supplies to more than 100 airports and has business worth 1 billion dollars annually.

CAO listed itself in Singapore stock exchange in 2001.

Huge increase in air travel volume and hence became major buyer of airlines and aviation fuel.

Income was subject to high volatility in oil prices.

CAO used Oil swaps for hedging purpose.

2003 started trading in Futures for speculative reasons.

Chen Jiulin (CEO) was expecting a fall in the oil prices to $38 per barrel but it went upto $55 per barrel.

Had to pay the banks and financial institutions the earnest money which was $5000 for 1 dollar rise in oil price barrel.

Turned to parent company which paid $108 million to CAO.

Parent company reduced its share from 75% to 60%.

CAOHC approached Deutsche bank to sell it stake through block trade.

Deutsche Bank offered 145 million CAO shares at $1.35 each,with 14% discount to market price.

By end of November CAO received payments demands for margin payments and settlement of Deratives trades from the following.

Unable to secure more funds Chen made it public that company made a loss of nearly $550 million in Derivatives.

The stock price fell steadily, loosing nearly 39%.

Chen was arrested for being involved.

Assets were not sufficient to meet the debts.

For meeting the creditors demands and to avoid bankruptcy CAO brought a reorganization plan.

CAOHC planned to convert part of $118 million loans to equity and invest additional $50 million.

Singapore state investment agency Temasek Holdings Pte.Ltd would invest another $50 million.

Investment would not proceed until the creditors accept the repayment plan.

The scandal had raised doubts about the reputation of Singapore which was regarded as a well-regulated financial centre.

Singapore's Prime Minister Lee Kuan Yew (Lee), who is also the father of modern Singapore, along with the government and people of Singapore head worked hard to create a corruption-free economy supported with infrastructure and stable political and financial system.

Singapore INC’s Challenge

The Singapore Exchange had made tremendous efforts to become an international exchange.

It received its first over seas application from Hong Kong in 1993, and since then had accepted 176 foreign listings by 2004, accounting for 27% of its total of 625.

Singapore provided a good alternative to Hong Kong, as Chinese companies found it difficult to get domestic listing due to poor market condition and regulatory restriction.

Singapore’s Stock Exchange’ foray amongst the major world markets.

Critics say that the CAO scandal had brought into spot light the short coming in the city-state‘ financial liberalization process, and this was not the first scandal to happen at the Singapore stock exchange.

In November 2004, three employee from the Government of Singapore Investment Corp, which manages Singapore’s foreign reserves were fined for insider trading in Japanese share.

In April 2004, former finance manager with Asia Pacific Breweries was jailed for 42 year for cheating Germany and Japanese banks of $71 million.

In 2001, Singapore- listed Asia Pulp and Paper, an Indonesian wood and pulp conglomerate, defaulted on debts totaling $13.9 billion.

The most infamous scandal was the collapse of the UK’s Barings Bank in 1995.

Scandals at the Singapore Stock Exchange…

Reasons for fall of Barrings bank Leeson – the trader was in charge of both

front office & back office

Lack of involvement of Senior Management

Company wanted only profits

Improper control procedures

To attract foreign companies to list their shares on the Singapore Exchange, the exchange had eased many rules and regulation.

But CAO had violated major laws……

Enterprises with overseas futures permit were only allowed to engage in hedge transactions and they are not allowed to engage in speculative transaction

Someone in the Singapore government was sleeping…..

It started speculating with 2 million barrels initially and the number had reached 52 million barrels by the time the scandal took place.

It had exhausted its $5 mn internal trading limits back in 2003, and also misrepresented its financial statement.

The total assets of CAO in June 2004 was $515 million and the assets-liabilities ratio was 73%.

With Chinese companies turning to foreign markets to raise funds, it had also raised an alarm for the creditors about the risks of investing in Chinese firms especially the state- owned enterprises.

Violations and Fraudulent non- disclosures by CAO…..

ConclusionCAO adopted intrinsic value method for

valuation of options failing to include the time value method

In 2004 Chen speculated oil price will be $38 per barrel but it shot up to $55 per barrel

Singapore Exchange(SGX) failed to enforce corporate governance

Three main causes of the downfall were:

Speculative oil trading and undisclosed losses in 2004

Improper risk management procedure

Failure of the board to fulfill its duties

Lessons to be learntThe strategic objectives and risk

management policy of the company must be determined at the highest level

Senior management must be responsible for the policies to be incorporated into daily operations

Internal and external reporting must follow best practice with frequent and detailed disclosures

There should be regular stress testing on strategy and risk measurement models

Prior to trading in new products, a formal analysis must be conducted on the risk profile of the product

The role of the CEO’s- whether they should aim for the objective of profit maximization to which their compensation is linked, or work in the interest of the shareholders for profit maximization?

With Singapore making great strides in corporate governance, should the companies be permitted to engage in activities that fly under the supervisory radar?

Questions……