Dilrook Kannangara

It was a meeting destined to happen. On one hand there is the unethical practice, especially in financial markets, of misselling that is spreading like a cancer around the world and on the other hand there is the CPC laden with corrupt and incompetent officials. Those who love the nation cannot and shouldnƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢t keep silent over this. This is outright robbery of public funds. Now the default dues with interest stand at over US$300 million. Given the total oil import bill of US$2 billion a year, US$300 million is 50 daysƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢ oil bill! In other words the nation could have been supplied with free fuel for close to two (2) months from the money wasted on the hedge.

Misselling is the Prime Cause of Economic Collapse around the World

Misselling is selling a (financial) product knowing very well that the buyer would not benefit from, be able to service or find it suitable. In western countries it is an offence. Although the age old adage ƒÆ’‚¢ƒ¢-¡‚¬ƒ”¹…”buyer be awareƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢ is applicable in all cases of selling goods and services, ethical practice is gaining momentum around the world given the complexities associated with financial products. It was misselling that ruined the US economy and dragged the world to Global Financial Crisis (GFC). Sub-prime mortgages were sold to unsuspecting buyers. Complex and at times contradictory statements, small letter conditions and salesmanƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s bluff were used to push these loans through. The end result was the near total collapse of the financial system plunging both the buyers and financial institutions into bankruptcy. Resultant panic and lack of investor confidence made the impact worse.

In 1998 similar events led to the Asian Financial Crisis (AFC) that affected Indonesia, Malaysia, Thailand and other regional nations. Indonesia was pretty badly hit with ugly political and social ramifications. Selling financial products tied to residential and industrial property development far in excess of affordability was the prime cause of the AFC. George Soros ƒÆ’‚¢ƒ¢-¡‚¬ƒ¢¢”š¬…” a global financial wizard ƒÆ’‚¢ƒ¢-¡‚¬ƒ¢¢”š¬…” made use of the opportunity to skim the foreign reserves of affected nations.

The CPC hedge case should be an eye opener for Sri Lankan authorities to enact new laws to prevent misselling, especially financial products. Sri Lanka survived the 1998 AFC and the 2009 GFC but it is just a matter of time since a similar crisis hit the island nationƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s economy.

Clear Indication of Fraud in the CPC Case

In the CPC hedge deal, the government corporation bypassed all the controls in place to prevent criminal exploitation of state entities. Attorney GeneralƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s Department was not consulted on the legality of the contract; the Central Bank was not consulted on the financial viability and authority to enter into the contract and internal accounting, administrative and internal control procedures were disregarded. Like the AesopƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s tale of the fox and the crane, the hedge was one sided. To quote a local fable, it is akin to the sharing of a cow by two farmers with one owning the front and the other the back of the cow. If crude oil prices increased over US$100 a barrel, the bank would compensate CPC for the difference subject to a ceiling of US$3 million. But if the oil price falls, CPC should pay the difference to the bank with no limit!

For example, if the crude oil price was US$110 a barrel and CPC purchased one million barrels, it would pay US$110 million. US$3 million would be compensated by the bank resulting in a net additional payout of US$7 million. On the other hand had the price fallen to US$90 million, CPC will have to pay the banks US$10 million. Either way the CPC loses! It was such a foolish contract to profit the banks, mainly Standard Chartered Bank, at the expense of taxpayer funds. CPC Board claims it was not informed of the deal which was done solely by its Chairman Asantha de Mel. His daughter Stephanie de Mel was employed by the Standard Chartered Bank according to informed sources. These sources further add she was employed in the division dealing in foreign currency trade! If true, it is a clear and most despicable case of collusion.

Culpability of CPC top officials is obvious as the nation stands to pay over US$300 million to three banks over the hedge deal which had no benefit for the nation. Whatever the complexities, it is clear US$300 million is payable by state funds. An offence has been committed and the culprits must be punished.

Standard Chartered Bank is Also at Fault

Although misselling is not a criminal offence in Sri Lanka, Standard Charted Bank acted in bad faith to profit from a deal calculated to cause loss to CPC. Complex conditions and the agreement to these by the buyer do not absolve the bank from its moral and ethical responsibility which it boasts of. Sri Lankan government must forthwith revoke its banking licence. SCB does not deserve to engage in banking in the island after indulging in immoral and unethical trade practices costing the country well over US$160 million in one deal. Misselling is a criminal offence in western countries. Due to these restrictions, western banks try it in backward jurisdictions where it is still not illegal. That is the rationale behind SCBƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s deal with the CPC. This may not be the last.ƒÆ’-¡ƒ”š‚ ƒÆ’-¡ƒ”š‚ ƒÆ’-¡ƒ”š‚ ƒÆ’-¡ƒ”š‚ 

Sri LankaƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s banking system has rapidly grown over the years. Following the war the banking sector promises phenomenal growth. Banks flock to reap the benefits of this economic surge. SCB should not be allowed to benefit from the fruits of peace which calculated to deplete the nationƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s foreign currency reserves at a time (2007) when the nation relied very heavily on the meagre reserves to finance the essential war effort and at the same time sustain economic growth. Absence of SCB in the picture does not cost the country a cent. On the contrary, it releases billions of rupees of banking business to be absorbed by other banks, especially local banks. It is better without the SCB. Send them packing.

It is a good opportunity to look critically at the role played by foreign banks in the island. A careful balance between local and foreign banks must be maintained at all times with national economic interests at heart.

Further Damning Consequences

All branches of the petroleum industry make profit in all countries but CPCƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s profitability and expansion are severely hindered by fraud and incompetence. The hedge fraud is already having a ripple effect! Following the court order and two more likely orders, the Treasury is committed to pay over US$ 300 million dues. In 2007 the Iranian government promised to assist the vital expansion of the Sapugaskanda Oil Refinery capacity from its current 40,000 barrels a day to 100,000. The project was to be co-financed by Iran and the government of Sri Lanka. Local contribution to the project was to be US$ 500 million. However, as the government is already committed to pay over US$300 million for the banks, there is no way a further US$500 million can be raised. In other words there is no way the government of Sri Lanka can raise US$ 800 million. Had it not been for the hedge fraud, it would have been only an additional US$200 million over the needless US$300 million payment that would be needed to start the project. An easy target.

Recently the refinery was undergoing regular maintenance. In order to meet the petrol demand, CPC had to import petrol on short notice. It was a disaster as substandard petrol hit the market damaging engines of countless number of vehicles.

Now the expansion project has been abandoned threatening fuel shortages, substandard fuel imports and expensive imports.

This is not the first instance of postponing vital expansion at the refinery. In 2002 the government invited private investments to carry out the expansion. However, what happened defied all logic. Investors demanded the privatization of the profitable fuel distribution arm of CPC instead of participating in the refinery process. The then government divested from the profitable fuel distribution operation but no investor was interested in the refinery project where capital was actually needed!

The entire CPC operation needs to be carefully looked at. This national asset destroyed over the years by neglect, fraud and incompetence must be revived to its true potential. People must demand from their elected representatives, answers, solutions and an end to this corruption. ƒÆ’-¡ƒ”š‚ ƒÆ’-¡ƒ”š‚ ƒÆ’-¡ƒ”š‚ 

Expert Legal Opinion Must be Sought on Further Default

Government defaulted on the payment stating the deal did not meet the proper authorisation procedure. It is a valid argument. However, SCB managed to get a court order in its favour in the UK. Two other pending cases in Singapore and Washington by two other banks may also get verdicts in their favour given the similarity in facts despite differences in law.

Whether the government should pay now or not must be carefully analysed. Continuing with default may not be the best option as it adds a huge interest burden. Defaulting on the dues means a drop in GOSLƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s credit rating. If the sovereign risk is assessed to be high, GOSLƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s credit rating will be downgraded and investor confidence will also suffer. A drop in credit rating affects the ability to secure and the interest rate of, loans from foreign entities. GovernmentƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s new financing option ƒÆ’‚¢ƒ¢-¡‚¬ƒ¢¢”š¬…” raising bonds directly abroad ƒÆ’‚¢ƒ¢-¡‚¬ƒ¢¢”š¬…” will also be affected by a drop in the credit rating.

However, emerging financing sources, especially from the East, donƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢t rely on the credit rating. They also have the benefit of lacking political conditions in the loans. All IMF, IBRD and other western loans come with many political conditions difficult to meet. Impact on the existing loan portfolio must also be carefully studied. Defaulting on the dues to the three banks that arranged the hedge may be pursued as an option only if it benefits the nation in the long run in the context of changing global financial balance from the west to the east.

Bold political statements unmatched by action will further ruin the economy.ƒÆ’-¡ƒ”š‚ ƒÆ’-¡ƒ”š‚ 

Political connections and personal friendships of the persons behind the deal should not be allowed to rob taxpayers and fuel consumers. Ruling UPFAƒÆ’‚¢ƒ¢-¡‚¬ƒ¢-¾‚¢s election success at future national elections is at stake as people demand punishment and a way out of this debacle. It is not about how corrupt the opposition parties are or how corrupt they may be when in power, but about how existing corruption can be defeated. Unless the government takes action to punish the wrongdoers, people will certainly punish them all.ƒÆ’-¡ƒ”š‚