Business Times

Losing round one in hedging scam

Losing one case (Standard Chartered vs Ceylon Petroleum Corporation - CPC) is bad enough. What if the CPC loses the other two, payment-due cases too, filed by Deutche Bank and Citi Bank?
The country would then be in the red for several million dollars at a time when the Treasury is running helter-skelter to manage rising government spending against less revenue in a Ceylinco Group-styled structure where the latter borrowed from one company to sustain another. Finally it crumbled, as the Sri Lankan public knows and Golden Key depositors are still waiting for their full dues.

According to ‘well-informed’ sources, the judgment in the Citi Bank arbitration (in Singapore) is believed to have been delayed in anticipation of the Standard Chartered ruling. Now that the fat is in the fire for Sri Lanka, the next ruling for the cash-strapped country in the Citi Bank case is ominous. In the Deutche Bank case, the claimant has filed action under the investment protection protocol between Sri Lanka and Germany. These cases are sure to blur the climate for investment in Sri Lanka and raise concerns as to whether foreign investors are protected given the Supreme Court judgments on reversing privatization of LMS, Water’s Edge and Sri Lanka Insurance, and now the CPC’s payments issue. The business community is complaining that these issues send disturbing signals to investors in that investments are not safe from Government intervention. However the courts must not be faulted for exercising justice. It’s the government of the day and the parties involved (government and private sector officials) who work hand-in glove in deal-making that beat the rules, and then end up in court. It’s corruption that should be blamed – not justice meted out by the courts.

Similarly the CPC and other authorities should be faulted for not acknowledging enough their inexperience in hedging their bets on an instrument that they didn’t have a clue about, and properly dealing with that inability. The court judgment reveals how former CPC chairman Asantha de Mel wanted the banks to advise him on oil movements and trends because CPC officials were inexperienced in such activity. “CPC contends that SCB held itself out to CPC as advisor and encouraged it to enter into transactions that did not hedge its risks, but instead provided the prospect of insignificant up-front fixed profits in return for taking on vast and disproportionate downside risk,” the ruling said.
Even if the contention is that such advice is provided internationally in these market-related trades, it beats one imagination to expect the bank or banks to provide ‘honest’ information on the market to a client.

For example would a bank have alerted the CPC that, based on their projections or view, oil prices would come down below the benchmark level when the CPC had to pay the banks? Highly unlikely as the bank stood to gain by millions of dollars.

The CPC should have hired an independent advisor instead of relying on ‘biased’ party (bank) advice. At fault clearly is the CPC, the Central Bank and the government. It was unfortunate that the bank didn’t also take former SCB staffer Kimarli Fernando’s advice seriously where in an affidavit to the Supreme Court, she spoke of how she had advised the bank against proceeding with the deal since CPC officials were clueless about the risk.

The judgment also reports on various dinners and lunches, family gatherings and Singapore trips by bank and CPC officials during the deal-making. While this is how big business is run in the corporate sector – throw money (invest) to make) money (profit) -, it’s another issue when its public money that is at stake and when accountability is paramount. There was no reference to the alleged corruption that took place in these transactions but the partying gives an idea of how ‘comfortable’ the client and the deal-makers were.

Sri Lanka has lost phase one of the oil hedging arbitration though the bank could face a huge liability through the stiff US$240 million fine imposed by the Central Bank for transferring money without permission. SCB has appealed to the Ministry of Finance urging that the fine be withdrawn or reduced. The bank has also gone to court appealing against the penalty.

There’s another school of thought that believes that both sides (Government and SCB) are equally at fault and should resolve the issue through a reduced fine or reduced payments claim, resulting in a win-win for all. It is learnt SCB is keen on continuing business in the country for many years to come and wants to put back the ugly episode and move forward.

It was the Sunday Times/Business Times that exclusively broke the news of the hedging scam in October/November 2008 and then everyone else including the opposition jumped the bandwagon and raised hell over the issue. The rest is history. “Was CPC board approval given? No. Were Central Bank guidelines followed? No. Did the banks get a written undertaking from the board understanding the risks? No. Were the board of directors made to fully understand the risks? No,” the paper said in a December 7, 2008 editorial. It said:

“The blame game has begun: Fowzie blames the CB Governor, the Governor blames the CPC Chairman and the CPC Chairman protects the banks saying they should be paid as any default will be perceived as a sovereign debt. Eventually while the opposition and public interest groups take the government to the ‘cleaners’, the banks would get away without any action unless the authorities bell the cat for a deal in which the country could lose very badly.”

No one paid heed. Now it’s more likely that payments claims will rise through the other cases and the public has to pay for a costly experiment that went wrong.

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