May 05, 2020 07:39 PM

Ling Huawei: Is ‘Paper Crude’ an Innovation or a Violation?

No matter how the losses are finally divvied up, one question needs to be taken into consideration: Who should be held accountable? Photo: IC Photo
No matter how the losses are finally divvied up, one question needs to be taken into consideration: Who should be held accountable? Photo: IC Photo

It was a black April for Bank of China (BoC). The state-owned bank failed in its crude oil investment through its Yuan You Bao crude futures trading product and caused nearly 10 billion yuan ($1.4 billion) of losses, failing some 60,000 investors and suffering a blow to its reputation. This starkly illustrated that BoC’s management of derivatives trading risks, an ability of which it used to be proud, falls far behind its competitors.

Key details of the case have not been made public by BoC or financial regulators, but media reports have disclosed the basic facts.

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In Depth: A Bitter, $1.4 Billion Lesson on Commodity Price Speculation

Discussions over this case have been heated in recent days, with the focus ranging from the oil price war and futures and derivatives trading rules to investor suitability, regulatory oversight, and stakeholders’ legal responsibility.

One consensus is that retail investors tried to “buy the dip” in crude futures through “paper crude” trading products offered by several large and midsized Chinese banks, only to see the price plunge into negative territory for the first time after CME Group gave the green light for West Texas Intermediate (WTI) crude futures to be traded and settled at negative prices.

Short sellers hunting investors with long positions is not a conspiracy, but a strategy. As trading rules and information are transparent, what the market tested was financial institutions’ risk management. Judging from the paper crude investment products’ design, investors’ losses should have been limited to the margin deposits in their trading accounts, and banks should have taken responsibility for other losses in extreme situations regardless of whether the failure was due to market or operational risks.

One question is whether investors who lost all their margin deposits can claim compensation from BoC, and how much they can claim. The essence of this question is whether the bank violated regulations by selling this crude oil futures product to retail investors. Did it violate the basic principle of investor suitability? Is the bank unqualified to sell such products? Or can it do so as long as it abides by the principle of investor suitability? If the bank is found to have violated regulations, should it bear some of the investors’ losses, as in previous cases in the futures industry, and in the case of Lehman Brothers’ “guaranteed mini-bonds” in Hong Kong? 

Some people believe BoC and a few other banks are qualified to engage in derivatives trading. Paper crude products were born in 2013 when China’s foreign exchange reserves surpassed $4 trillion, foreign exchange regulations were loosened, and the internationalization of the yuan began. Some retail investors began to learn how to trade crude oil, allocate assets globally and take risks accordingly. Since they demanded these products, financial institutions should be able to serve them after a cost-benefit analysis, some industry insiders say.

But the problem is that the banks have lowered the threshold for ordinary retail investors to trade global futures, which should have only involved institutional investors and large individual investors, as trading in WTI crude futures begins at 1,000 barrels at a CME exchange. Such a practice increases the liquidity in the market and meets customer demands. Is it an innovation or a violation of regulations? And how to cope with it in the future?

Sometimes financial innovation is about bypassing outdated regulations and creating new value for customers and the market. It is normal for regulations to lag behind innovation. What is important is that regulators should fully assess problems when they appear and understand whether stakeholders’ costs and benefits have been allocated reasonably, investors’ legal rights have been violated, and financial risks have been effectively controlled. Regulators should also figure out whether or not financial institutions have ensured that the risks are borne by suitable investors. In the case of BoC’s paper crude oil investment, no matter how the losses are finally divvied up, one question needs to be taken into consideration: Who should be held accountable?

Some people have suggested that regulators disclose the details of this case and respond quickly given the market’s concerns. I hope regulators would not just take a “one-size-fits-all” approach to deal with the problem and simply ban innovation out of fear. They should identify the reasonable factors in financial innovation and regulate the key issues.

Ling Huawei is managing editor of Caixin Media and Caixin Weekly.

This article has been edited for length and clarity.

Contact translator Guo Yingzhe (

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