Citic Pacific emerges badly scarred by its currency speculation
By Tom Mitchell in Beijing and Justine Lau in Hong Kong 2008-10-23

This month, as the Australian dollar plummeted almost 25 per cent against its US counterpart, Larry Yung and his senior management team at Citic Pacific watched with alarm.

The Hong Kong-listed arm of China International Trust and Investment Corp (Citic) China's largest state-owned investment group, had committed itself to large purchases of Australian dollars and euros on the assumption that the two currencies would continue to appreciate against the US dollar.

After the opposite trend emerged this summer, Citic Pacific found itself saddled with losses of US$1.88bn at current mark-to-market prices. That is more than three times the US$560m the company booked in profit for the first six months of this year. Yesterday, Citic Pacific's shares fell 55 per cent to HK$6.52, meaning the estimated forex losses now exceed the company's market capitalisation.

With the US dollar strengthening dramatically since the onset of the global financial crisis, Citic Pacific's losses could widen even further. The company must mark-to-market for reporting purposes on December 31. Nor will its problems end with the new year. Citic Pacific is contracted to buy more than A$9bn through October 2010.

State-owned China Inc has been burned on the international commodities markets before. But such stumbles have involved relatively obscure actors – such as the Singapore-based executives for China Aviation Oil, who lost US$550m on oil futures contracts in 2004, and a “rogue” Shanghai copper trader in 2005.

Citic Pacific is supposed to be a jewel in China's overseas corporate crown, with a management pedigree that approaches royalty in communist China. Mr Yung is the “red tycoon” son of “red capitalist” Rong Yiren, the late Chinese vice-president. In addition to Citic's controlling 29 per cent stake in Citic Pacific, Mr Yung personally owns another 19 per cent of the company.

Perhaps armed with knowledge of the crisis at Citic Pacific, earlier this month the country's market regulator summoned the heads of 25 state companies to remind them they could hedge, but not speculate, on overseas commodity markets. Citic Pacific, which has extensive interests in property, infrastructure and steel, first learned of its foreign currency exposure on September 7 and later secured a US$1.5bn standby loan facility from its parent.

Citic Pacific's misadventure began when the conglomerate committed itself to the purchase of billions of Australian dollars – and smaller amounts of euros – at an average rate of A$1:US$0.87 and €1:US$1.44. Citic Pacific, which had recently diversified into Australian iron ore mines, did so “with the objective of fixing the cost of this expenditure in US dollars”.

But while the contracts limited losses for Citic Pacific's counterparties if the Australian dollar surged through the A$1:US$0.87 “strike price”, there was no similar protection for the conglomerate if it fell. When the Australian dollar plunged to US$0.64 this month – and the euro retreated to US$1.35 – Citic Pacific was staring at billions in potential losses.

Mr Yung said Citic Pacific's bet was made without authorisation by the company's group finance director, Leslie Chang, and not challenged by its financial controller, Chau Chi-yin. Both Mr Chang and Mr Chau are stepping down.

“I was shocked,” Henry Fan, Citic Pacific managing director, told the Financial Times yesterday. “I asked Leslie how could this happen, and he said he omitted to assess the downside risk.”

“As managing director, I am happy to take full responsibility,” Mr Fan added. “The board is going to take full responsibility. It will be reflected in our pay.”

He added that Mr Yung's daughter Frances, listed as “director, group finance” in the company's annual report, had been demoted and her pay cut.

Citic Pacific took its positions as the Australian dollar and euro were in the middle of a steady, two-year ascent against the dollar that finally ended in July of this year. Over the past fortnight, the Australian dollar has recovered 9 per cent against the greenback. Mr Yung and his colleagues in Beijing can only hope that continues.