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Investors who bought Bank of China’s oil derivatives product gather to protest in front of the bank’s main building in Guangzhou on April 24. Photo: EPA-EFE

Bank of China oversteps regulations in passing derivatives off as wealth management. And it’s not alone

  • Several bank officials say the crude oil derivative products effectively overstepped regulations that bar the country’s lenders from operating as commodities futures brokerages
  • Bank of China says it will compensate 20 per cent of investors’ original investments in the oil-linked product, according to investors

China’s commercial banks have sold financial derivatives packaged as wealth management products that slipped through regulatory cracks, giving individual investors access to risky foreign commodity futures contracts, according to several bank officials familiar with the matter.

One such product is Bank of China’s Crude Oil Treasure product that burned a 7 billion yuan (US$987 million) financial hole through the bank’s books and among customers. Other banks too offer similar products but their clients have avoided the fate of Bank of China customers because of earlier redemption dates or rollover before crude prices crashed into negative territory.

Several bank officials with China Construction Bank, Bank of Communications, Shanghai Pudong Development and Industrial and Commercial Bank of China, all of whom spoke on condition of anonymity, said the Crude Oil Treasure product, allowed customers to build up positions based on the West Texas Intermediate (WTI) or Brent International contracts and effectively overstepping regulations that bar the country’s lenders from operating as commodities futures brokerages.

Crude Oil Treasure was catapulted into national limelight on April 21 when May WTI contracts crashed to minus US$40.32 a barrel, causing mainland investors losses to the tune of about 7 billion yuan, according to media reports. Those clients who built buy positions on that day lost all their margins and owed Bank of China a massive amount of money.

Bank of China’s Crude Oil Treasure product has burned a 7 billion yuan financial hole through the bank’s books and among customers. Photo: EPA-EFE

Lawyers have cast doubts on the legality of the product as they help investors seek compensation from Bank of China for their losses.

Yang Zhaoquan, a partner at Beijing Weinuo Law Firm, who says he is representing more than 100 investors against Bank of China, said the wealth management obscured its role as a brokerage service offered to the clients, which is barred on the mainland.

Bank of China’s US$1 billion hole from plunging oil

“By buying the product derived from commodity futures, investors are indeed making investment in futures contracts,” said Yang. “The service has gone beyond the banks’ business scope.”

Huang Lei, an independent futures market analyst, said the product was akin to a brokerage service as it paved the way for individuals to directly trade on overseas futures markets.

No mainland institution is allowed to offer brokerage services for individual investors in China to trade futures abroad.

Under the Crude Oil Treasure scheme, banks act as market maker on a virtual trading platform to trade against the clients when they build either long or short positions in oil contracts. The banks then build up a position on the global market based on the clients’ bets. By doing this, banks actually close their own position on the trading platform while taking no risks arising from the price volatility. It is the individual investors who are exposed to the risks of fluctuating oil prices that will generate either returns or cause losses to them.

Huang Mengqi, a lawyer and co-executive director at Beijing DHH (Shanghai) Law Firm, who claims to represent more than 600 investors with a combined loss of 100 million yuan in a class-action lawsuit against Bank of China, said the lender was never entitled to do commodity futures businesses or offer financial derivatives based on futures contracts.

A China Construction Bank official said that commercial lenders were confident that the derivative, after being designed as a wealth management product, had fully complied with the banking regulator’s rules. Customers were actually chasing the swings in global crude oil prices on the virtual trading platform, and they were not buying or selling contracts on the overseas exchanges, he added.

The product was endorsed by the China Banking and Insurance Regulatory Commission (CBIRC). The CBIRC did not respond to queries about the product’s legality. The regulator said in a statement last weekend that it had requested Bank of China to iron out the problem by negotiating with the victims in a caring and prompt manner.

Screenshot of a short message sent by Bank of China on April 16, 2020, warning customers of its Crude Oil Treasure financial product of the impending expiry of WTI futures contracts. Photo: Handout

Bank of China said in a statement on Tuesday evening that it has studied and responded to clients’ demands. If the clients do not resolve the dispute through its proposal, then it would have to resort to the legal process.

Several investors told the Post they have received proposals from the bank that it would compensate 20 per cent of their original investments and shoulder all losses in negative territory.

Zhao Changyi, a leading financial risk management expert in China, said the crisis showed that risk control remains the weakest link in China’s banking and insurance sectors after three decades of rapid development.

“China’s banks still lack risk awareness and risk control capabilities to avert sharp losses when they grapple with black swan events,” said Zhao, head of China’s training programme for financial risk professionals at the State Administration of Foreign Experts Affairs. “There is a bunch of loopholes in China’s financial system that need to be mended by qualified and talented risk management professionals.”

China’s individual investors however have access to global crude oil contracts. There are currently a handful of exchange traded funds on both Shanghai and Shenzhen stock exchanges which track indices linked to the WTI futures contracts. These funds are sold under the qualified domestic institutional investor scheme, which allows asset managers to invest in offshore securities.

The sun sets behind a crude oil pump in Loving County, Texas. Crude prices have been battered in recent weeks. Photo: Reuters

With assets totalling 3.8 billion yuan, some ETF fund managers had in early April warned investors in public disclosures about potential losses from volatility of the WTI futures and their capital invested.

There are always options for a manager of these products to either sell the futures contracts on the secondary market, or roll the front month contracts to those of the following months well ahead of the settlement date, said Patrick Heusser, senior trader at Crypto Broker based in Zurich.

“If you are a risk averse and experienced commodity trader you will definitely take that approach. There is no need to hold a futures contract till settlement,” said Heusser.

In the case of Bank of China, the product was not designed to roll over the futures contracts earlier than the settlement date. According to the bank’s disclosure on its website, it would only roll the contracts or close out the positions in the global market on the settlement date.

This article appeared in the South China Morning Post print edition as: Bank’s repackaged oil ‘wealth’ product burned investorsOil scheme a risk for mainland investors