Western Banks in China: Collateral Damage

Chinese companies are playing hardball with a handful of banks over certain derivatives deals, but the implications go well beyond the money directly at stake.

Author:: Dan Freed
Publish date:: Sep 10, 2009 1:00 PM EDT

NEW YORK (

TheStreet

) -- Chinese companies are playing hardball with a handful of U.S. and European banks over certain derivatives deals, but the implications go well beyond the hundreds of millions of dollars at stake in this instance.

Several banks in the U.S. and Europe, including

Goldman Sachs

(GS) - Get Report

Citigroup

and

Bank of America

(BAC) - Get Report

have large investments in Chinese financial companies.

American International Group

(AIG) - Get Report

also has a big stake in China via its American International Assurance unit.

At issue are certain oil derivative contracts involving

China Eastern Airlines

Air China

and

China Ocean Shipping

. These companies sent letters to foreign banks including

Deutsche Bank

(DB) - Get Report

, Goldman,

JPMorgan Chase

(JPM) - Get Report

, Citigroup and

Morgan Stanley

(MS) - Get Report

, stating that they have the right to default on obligations under the contracts, according to a report Thursday in

The Wall Street Journal

While it isn't clear if the companies will carry out their threats to tear up the contracts, the report states that the Western banks may very well have to swallow the losses if the Chinese companies decide not to pay. On the flip side, the Chinese companies need to be able to hedge against fluctuations in oil prices, so they may not want to risk losing the ability to do that in the future.

What the case highlights, however, is the difficulty of doing business in China. While banks including BofA have succeeded in reducing their stakes, doing so tends to be fraught with political peril, as the Chinese tend to take a much longer-term view of investing than most Western institutions.

Tensions in U.S. business relations with China are also heating up outside the banking industry. On Wednesday, the U.S. Commerce Department made a preliminary decision that Chinese tubular steel is unfairly subsidized, according to a report from Concept Capital, a New York-based brokerage firm. The report says the decision is negative for U.S. companies that extract oil and gas from the ground, including

Anadarko Petroleum

(APC) - Get Report

Apache

(APA) - Get Report

Devon Energy

(DVN) - Get Report

and

XTO Energy

(XTO)

as they will be required to start making deposits to offset the effect of the subsidy.

Written by Dan Freed in New York