-->http://quote.bloomberg.com/apps/news?pid=10000039&refer=columnist_pesek&sid=a6LD1JQqfEJs

Has a Chinese Enron Popped Up in Singapore?: William Pesek Jr.

Dec. 8 (Bloomberg) -- In 2002, China Aviation Oil (Singapore) Corp. was named Singapore's most transparent company by the island's Securities Investors Association. No doubt the group is regretting that decision.

The Singapore-based company is being investigated for speculative oil-trading losses it hid from investors. The $550 million derivatives-trading loss is Singapore's biggest since trader Nick Leeson brought down Barings Plc in 1995 with more than $1.4 billion in losses. The stakes are high: Former Prime Minister Goh Chok Tong says the city's reputation as a financial center will rest on how well it handles the investigation.

Yet China Aviation Oil's story may say less about Singapore than the risks of investing in China's booming economy.

The big question is whether this is China's Enron Corp. No one knows where the China Aviation Oil saga will go from here -- all this has yet to be proven in court -- yet it could be the seminal event that prompts a reassessment of an entire economy and its companies, just as Enron's collapse was for the U.S.

At a minimum, China Aviation Oil shows how China's challenges can spill over and undermine other markets. Hundreds of state-owned Chinese companies have sold shares in Hong Kong, New York and Singapore. China Aviation Oil is an important reminder that such companies -- a foreign unit of a Beijing company -- can feature less transparency and lax corporate governance.

A Must Risk

``Complex corporate structures and unreliable accounting practices make it difficult to perform substantive analysis on some China-related companies,'' Standard & Poor's said last week. ``On the accounting side, the problem of limited disclosure is compounded with problems of compliance.''

That's not the image many investors have of the world's most dynamic economy. Its 9 percent growth, 1.3-billion-person- population and rapidly growing influence in global affairs have convinced the worldliest of executives and investors that China is a risk worth taking. More to the point, it may be a risk they can't afford not to take.

China is the national equivalent of Internet companies during the late 1990s. Investors and corporate executives seem to have little time for a discussion of the risks. Such a `China.com' is run by geniuses and it's all good. It's Asia's New Economy and anyone who doesn't see that is a fool.

China's `Vinik Effect'

Think of it as China's answer to the ``Jeff Vinik Effect'' that pervaded stock markets in the 1990s. Vinik used to manage Fidelity Investments' flagship Magellan Fund. He grew bearish on technology stocks in 1995 and loaded up on bonds. The bond market soured, technology shares boomed and Vinik resigned in May 1996 as Magellan's performance plummeted.

The episode became all too common for dot-com era skeptics. At the time, even Warren Buffett was being dismissed as a dinosaur for saying he didn't understand dot-coms and their creative accounting techniques. Even fund managers skeptical of the stock mania coursing down Wall Street held their noses and bought shares in dodgy companies.

It's hard to ignore China's potential. That explains why everyone from executives at Wal-Mart Stores Inc. to the smallest venture capital firm in Silicon Valley is spending more time in China these days. And when you think of the rapid growth in its economy, markets, companies and consumer wealth, it would be a mistake to avoid Asia's No. 2 economy.

Using Other Countries

Investing in China is hardly a no-brainer. Its equity markets are a work in progress. Its bourses are fragmented, at times illiquid and vulnerable to speculative mania. There's also little correlation with China's growth rates and the performance of equity markets. And corporate governance can be a contradiction in terms. Hence, many people invest in Chinese companies through the markets of third countries.

Institutional investors are now painfully aware that that doesn't always work. China Aviation Oil disclosed its trading losses a month after its state-owned parent -- China Aviation Oil Holding Co. -- sold S$196 million ($119 million) shares to investors. Buyers included Temasek Holdings Pte, Singapore's state-owned investment company.

Judging from China Aviation Oil's stock, investors had few questions with management. Shares more that tripled between December 2001 and late November when it announced its trading losses. Company officials knew of their losses last month when predicting this year's profits would outpace last year's, the Financial Times reported. All this sure does sound a bit Enron- esque.

Seeking Handout

Temasek, and China Aviation Oil's parent company, are now being asked for a $50 million handout. If Temasek does contribute, it may have more to do with improving ties with China than economics. Temasek, after all, could lose even more if the company fails.

Yet the last thing China wants to see is a company that supplies a third of its jet fuel, that's listed overseas and that now is globally known go bust. And Singapore's economy has much riding on a strong relationship with Asia's most dynamic economy. Trade between Singapore and China grew more than 30 percent in 2003 alone.

No matter how all this plays out, China Aviation Oil is a timely wake-up call for those who think China's 9 percent growth will shield them from problems there. Ditto for those who thought investing in other countries' markets would save them from ugly surprises.

If this scandal turns out to be the tip of the iceberg in terms of China-related risks, investors are in for a rude awakening.



To contact the writer of this column:
William Pesek Jr. in Tokyo at wpesek@bloomberg.net