By staff reporters Zhang Fan, Wang Xiaobing, Li Qing in Beijing and special correspondent Kevin Foley in Singapore
From Caijing Online

Chen Jiulin knelt on the ground and lit a column of incense. For the first time in 11 years, he visited the grave of his grandfather in Baolong village, Hubei Province and said goodbye to his ancestors as smoke rose. He was preparing for a long journey.

Three days later, he walked off an airplane in Singapore and was immediately whisked away by plain-clothes police officers.

Chen, the 43-year-old CEO of Singapore-listed China Aviation Oil (Singapore), was taken into custody for investigation into Singapore’s worst financial scandal in nearly a decade. CAO filed for bankruptcy on November 30, citing losses of some US＄ 550 million from oil derivatives trading. The net assets of CAO Singapore were estimated at a mere US＄ 145 million.

Although Chen was released on bail the next day, Singapore police are still looking into possible violations of the Securities and Futures Act.

Almost immediately after the November 30 filing, Chen returned to Beijing at the order of the Chinese government-owned parent company, China Aviation Oil Holdings Company (CAOHC). The departure stirred up an outcry in Singapore, where analysts and officials were comparing the CAO scandal to the 1995 collapse of Barings Bank of the UK, triggered by the trading losses of rogue trader Nick Leeson. After reporting to his seniors in Beijing and taking care of family business, Chen flew back to the city-state on Dec. 8.

Caijing’s investigation into CAO’s fiasco has revealed a story of ignorance, gross violations and official indecision on the part of Chen and his seniors in Beijing. Documents, which Caijing has uncovered, show that Chen Jiulin and CAO management doggedly gambled against hiking global oil prices by increasing the amounts of oil futures it held, only to send losses from the initial US＄ 5.8 million to a staggering US＄ 550 million.

More shockingly, evidence shows that CAO’s Beijing parent, CAOHC, could have capped the subsidiary’s losses at US＄ 180 million by forcing CAO to take emergency stop-loss measures. Instead, the parent company allowed Chen’s maverick speculations to continue, even as losses spiraled out of control, forcing CAO to file for bankruptcy. On October 21, CAOHC, well knowing that its Singapore-listed arm faced grim financial risks, sold 15% of CAO’s shares to some fund management companies, in apparent violation of insider-trading regulations. CAOHC gave the proceeds to CAO in hope of rescuing it.

Few people would imagine that Chen Jiulin, the fourth highest-paid CEO in Singapore as of 2003, knew next to nothing about risk control in oil derivatives trading.

"I placed too much trust in others," Chen told Caijing in an interview during his brief stay in China before returning to Singapore. "The company has three safeguards (to ensure that nothing goes wrong in the derivatives trading): senior traders, the risk-control committee, and the internal auditing department."

Chen also admitted that he had no idea CAO would later be to required to pay huge amounts in margins as a result of its trading. "There is no way we could raise so much money," he said.

By engaging in large-scale speculative trading, Chen has also repeatedly violated strict prohibitions by Chinese regulators. Following a series of scandals in the 1990s involving huge losses incurred by state-owned firms in international futures trading, the Chinese Securities Regulatory Commission (CSRC) and other government organs banned domestic firms from futures trading overseas. In as late as 2001, the central government reiterated its ban on high-risk trading.

Chen, who was appointed to serve in the Singapore subsidiary in 1997, took no heed. When CAO launched an IPO in Singapore in November 2001, its prospectus listed oil derivatives trading as one of its businesses. "I was overseas and under the jurisdiction of Singapore laws," Chen said.

Sources told Caijing that CAO entered the oil futures market in late 2003, and with some success. By the end of the year, it had a short position of some two million barrels and was making money.

In the first quarter of 2004, however, CAO’s fortunes took a turn for the worse when oil prices surged. Sources close to CAO told Caijing that by March 28, the company was already US＄ 5.8 million in the red, due to losses from derivatives trading. At the recommendation of Cindy Chong, head of CAO’s risk control committee, and senior trader Gerard Rigby, Chen decided to extend the maturity of the futures held by CAO, as well as dramatically increase the size of trading. As a result, the losses were not immediately reflected in the company’s books.

On April 1, CAO published its annual report for fiscal 2003, proudly showing a net profit of some US＄ 32.89 million. Its share price soared immediately to SG＄1.76 (US＄ 1.07). However, what investors did not know was, with the hike in global oil prices still showing no signs of slowing, CAO’s book-value losses would reach US＄ 30 million within two months.

Some members of CAO’s risk-control committee voiced worries that the losses would grow out of control, but according to sources close to the company, most executives felt they could offset the deficit by digging in their heels and further extending the futures held by the company. Again, Chen favored taking risks to save profits, and decided to extend the maturity date of most of the futures CAO held to 2005 and 2006. Trading volume ballooned.

"Chen had analyzed oil prices at LIFFE and NYMEX for the past 21 years, and found that average prices, even in war times, never exceeded US＄ 34," said one Singapore source close to Chen. "He felt extending maturity was the best choice. The risks were small, and he might even make money," said the source, who remarked that Chen was exceptionally confident at the time.

Critics have suspected that CAO had no risk-control mechanism in place after the problems arose. But Caijing found out that the mechanism did exist, at least in form. The company’s risk-control manuals are developed by the consulting firm Ernst & Young, and fashioned similar to other international oil companies. In addition, CAO has a seven-member risk-control committee, staffed by Singaporean employees.

The company also has internal rules that any trader losing more than US＄ 200,000 must report to the committee and to the CEO personally for losses above US＄ 375,000. The rules also stipulate mandatory stop-loss measures after losses reach US＄ 500,000.

Ironically, Chen never knew exactly what those rules meant. "The US＄ 500,000 must refer to actual losses - all our losses were book-value losses at the time, which didn’t count," he told Caijing on December 7.

But Chen’s misunderstanding doesn’t quite explain how the company and its Beijing parent could have allowed losses to grow almost one hundred-fold within eight months.

"Either the risk-control mechanism was not activated at all, or someone was lying," said a senior oil derivatives trader in Singapore, on condition of anonymity.

Chen’s daredevil speculation continued through October, as he repeatedly sold short positions, or sold futures that CAO didn’t actually own, in hopes of recovering the losses brought about by sky-rocketing oil prices.

In October, Chen said he found out that total volume of futures trading CAO held was 52 million tones, or three and a half times its total annual imports. Most of the futures it held, or 79%, were to mature in 2006.

As oil prices kept rising, the margin requirement on CAO’s futures trading also surged, threatening to drain its cash flow. On October 10, CAO’s books showed it had suffered losses of US＄ 180 million. Chen had exhausted all the company’s financial resources to pay margins, including US＄ 26 million in cash, US＄ 120 million in bank loans originally intended for purchasing shares in stake in Singapore Petroleum Co., and US＄ 68 million in due debt payments. Still, CAO faced a US＄ 80-million shortage in meeting its margin calls.

It was at this time that Chen sent the first distress signals to CAO’s Beijing parent, CAOHC. In a proposed "internal rescue plan," he asked for as much as US＄ 250 million in loans. Alternatively, Chen told his seniors in Beijing, they could seek to raise funds from foreign or domestic oil giants. Chen traveled back to Beijing soon after turning in the proposal. He told CAOHC leaders that he would assume responsibility for the losses, but at the same time promised to recover the loss if he were given the loan.

Despite the shocking size of Chen’s futures trading and heavy losses CAO had suffered, CAOHC leadership initially approved his plan. On October 20, Jia Changbin, the chief manager of CAOHC and chairman of CAO, flew to Singapore to ink a deal, selling 15% of the CAO shares held by the parent company to institutional investors. Neither Jia nor Chen disclosed to the buyers the troubles at CAO. CAOHC raised US＄ 108 million in the sale and immediately loaned the entire amount to CAO.

Following the cash injection, senior managers sent in by the Beijing parent took control of CAO’s operations. On October 26, CAO’s biggest trading partner and creditor, Mitsui & Co. Energy Risk Management, pressed it to pay overdue margin calls. CAO had to cut loss partially at US＄ 55.43 per barrel, suffering some US＄ 132 million in actual losses. On November 8, it was again forced to cut loss, this time losing another US＄ 100 million.

Yet on November 12, CAO told investors in its third-quarter filing that the company expected its 2004 profits to surpass 2003 profit levels and reach a historic high.

Sources close to CAOHC told Caijing that in the month between late October and late November, top leaders of the state-run group hesitated between saving CAO or allowing it to fail. As senior CAOHC leaders and Chen shuttled back and forth between Beijing and Singapore, CAOHC informed state regulators of its dilemma. The State-owned Asset Supervision and Administration Commission (SASAC), the central government’s watchdog for state assets, was briefly supportive of the rescue plan and went as far as asking for foreign currency quotas for hundreds of millions in US dollars from the State Administration of Foreign Exchange (SAFE).

The SASAC, however, soon changed its mind, ruling instead that the state would not go against its own principles to rescue a wayward company. As the central government decided against injecting state funds to rescue CAO, and warned other state firms not to do so, cutting off CAO’s cash flow. The Chinese Securities Regulatory Commission, upon learning about CAO’s losses in mid October, recommended that senior management of the company be punished.

CAOHC, however, was not ready to throw in the towel, and refused to take instant cut-loss measures. By November 25, CAO’s actual losses had reached US＄ 381 million, landing the listed firm into technical bankruptcy.

The Supreme Court of Singapore, on December 10, granted CAO Singapore six weeks to come up with a debt-restructuring plan. The Singapore state investment firm, Temasek Holdings Pte. Ltd, and CAOHC have each promised US＄ 50 million to help rescue CAO Singapore.

In China, airlines are now expressing concern that the rescue operation will lead to surging fuel costs, since CAOHC is the country’s monopoly importer of aviation fuel.

Chen, the man at the center of the scandal, remains as confident as ever in his abilities. "If I can get just another US＄ 250 million, I am sure I will turn things around," he said in a mobile phone message to a Caijing reporter on December 9, soon after he was freed on bail.

Apart from confidence in his own gambling skills, Chen also believes that the Chinese government has a responsibility to bail CAO out. "CAO represents a standard of Chinese enterprises overseas," he said.

Indeed, until the firm’s reputation sank with its bankruptcy filing on November 30, it was a flagship for Chinese firms operating overseas. In 2002, it was picked by Singapore investors as one of the 56 "most transparent companies" in the city-state, and has since been ranked among the best performing Chinese companies overseas.

But the secret to CAO’s success lies primarily with its parent company. Formerly known as the China Aviation Oil Supply Corp., CAOHC is the monopoly supplier of aviation fuel to Chinese airlines. After Chen was appointed head of the Singapore subsidiary in 1997, he transformed CAO from an oil shipper into a wholesale buyer. By 2000, more than 98% of CAOHC’s total supplies came from CAO.

This exclusive link to the vast Chinese market explains CAO’s phenomenal success in recent years. A senior Singapore-based futures analyst told Caijing that CAO’s margin account had only US＄ 2,000 in it in 2002, an amount later boosted to US＄ 16 million.

"Why would trading partners continue to adjust its credit upward? Why would Deutsch Bank arrange its share transaction without conducting due diligence?" asked the analyst. "It maybe because of their blind faith in a Chinese state-owned enterprise."

That blind faith has cost investors and business partners dearly.

Satya Capital, a group of Indonesian investors, are suing CAO and its parent, seeking S＄ 47.16 million (US＄ 28.63 million) in damages after CAO backed out of an agreement to buy a 20.6% stake in Singapore Petroleum Co. from Satya in late November. The deal had been estimated to be worth some S＄227 million (US＄ 137.82 million).

Many small investors in Singapore told Caijing that they are outraged by CAO’s failure to timely inform investors of its losses.

Chen Jiulin has insisted that he has done everything in his power to steer CAO out of its troubles and protect investors. "With a peaceful mind I face all the crimes alleged against me; I blame myself for errors made, although I did do my best for the public," reads a poem he wrote before returning to Singapore and showed to a Caijing reporter.

English version by Wang Feng