Financial Times

Probe against banks, officials continue

Controversial oil hedging contracts
By Feizal Samath

A possible withdrawal of fundamental rights petitions in the Supreme Court against the controversial oil hedging contracts by the Ceylon Petroleum Corporation (CPC) is unlikely to affect independent investigations against the five commercial banks and allegedly corrupt officials by the Central Bank and the anti-corruption commission.

Concern was raised earlier this week that the banks would go ‘scott free’ after the Supreme Court said it may have to vacate interim orders issued in the case if the petitioners sought to withdraw the petitions.
Central Bank (CB) Governor Ajith Nivard Cabraal told The Sunday Times FT that their investigation is proceeding in terms of the Monetary Board Act in line with an earlier court decision that the CB should act according to ‘its own laws’. He said any vacation of the court order won’t affect the CB probe.

Neville Guruge, Director Investigations of the Commission against Bribery and Corruption, said they are also proceeding with the probe and have deployed a special team to conduct investigations into the controversial hedging deal.

He said they have to go through many documents to ascertain who was responsible for the corrupt deal and to conduct in-depth investigations based on an initial report submitted to them by the CB on the deal between the CPC and some banks.

When hearing in cases relating to the hedging scandal came up this week, the court said the government must comply with the court ruling or explain why it cannot do so. A court decision to reduce petrol prices to Rs 100 per litre was not implemented by the government which instead came up with a wider package of fuel and other relief to consumers. Petitioners in the case say they will withdraw the petitions if the government doesn’t fully implement the court ruling. The court says in such a case it will dismiss the case and remove the interim orders in which payments by the CPC was suspended to the five banks – Standard Chartered, Citi, Commercial, People’s and Deutsche.

The hedging issue relates to millions of dollars the CPC owes the banks due to a botched deal with them which was heavily in favour of the banks when prices fell to as low as $30 per barrel. Oil prices since this year have picked up to around $40.

Other CB officials, who declined to be named, said that with no ‘escape’ route for the banks to recover the money from the CPC and difficulty in challenging the CB findings, these institutions are seen considering putting diplomatic pressure on the CPC and the government. “Whatever the situation, they have violated CB rules and will be dealt with accordingly,” one senior official explained.

Hedging affected another company last week. ACL Cables informed its shareholders that it expects a significant decline in the company’s profitability following exposure from hedging contracts entered into by the company.

“Although these contracts, which are entered into by the company as a part of its routine business risk management operations for stabilizing prices of its base raw material, Copper, have resulted in hedging-gains in the past, the steep and unexpected decline in global copper prices at the London Metal Exchange over the past few months has resulted in the significant financial exposures to the company,” the statement said.

The unnamed CB officials said the five banks have not responded to an earlier communication by the CB on December 16 where the banks were ordered not to proceed with the transactions. The December 16 letter says the transactions have violated CB regulations and that they should be discontinued. In an earlier December 4 letter to the People’s Bank (PB) – a copy of which is in the possession of this newspaper -- the CB said the PB has not fully complied with provision of CB Directions of December 21, 2005 on financial derivates.

The letter by Bank Supervision Director, B.D.W.A. Silva to People's Bank (PB) General Manager M. Wickremasinghe said the PB had failed to carry out an adequate credit risk, market risk and operational risk and if .

if such a review been carried out, it would have ‘been clearly known by you as to whether the CPC had put in place transparent and adequate controls which were necessary to identify, understand and assess the substantial risks the CPC was undertaking in relating to hedging contracts.’ The letter notes that the PB had failed to assess the creditworthiness of the CPC to fulfil its obligation arising from the downside risk of the hedging contract, and that it failed to set an appropriate policy limit before entering into a contract.

Banking industry officials said a similarly-worded letter had been sent to other banks too involved in hedging where it was stated that the parties had not signed the International SWAP Dealers Association (ISDA) Agreement with the CPC, which is a standard risk mitigating procedure for entering into hedging transactions.

The CB letter said the CPC had entered into two contracts when oil prices were clearly falling. “On that basis, the CPC had entered into similar contracts with several banks, and it is highly unlikely that you have been unaware of such contracts.”

The CB said the CPC had a weak operating performance as reflected by its profit of $98 million in 2005, an operational loss of $18 million in 2006 and a profit of $36 million 2007. “In view of such weak earnings, it is questionable as to how your bank could have concluded that the CPC would have been in a position to absorb losses with magnitudes of over $300 to $400 million in the event of a downturn in oil prices,” the CB director asked.

It said the PB had also failed to fully and comprehensively inform the entire Board of Directors of the CPC of the structure and potential risks associated with hedging instruments.

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