Easy Profits for UBS Raise Eyebrows

The alumni of bulge-bracket investment banks had an occasion for a cynical laugh on December 26 when the Swiss bank UBS AG denied Chinese media reports that it had improperly manipulated shares and warrants in the Hong Kong listed H shares of PetroChina around the time that PetroChina’s A shares were being listed in Shanghai in early November.

"These allegations are entirely new, and at this stage UBS does not believe that they have any merit whatsoever," the bank said in an emailed statement to the media. Note the careful hedging of the phraselogy: “entirely new” and “at this stage” UBS “doesn’t believe they have merit”. So the management does not know the facts? Or are they just trying to find a way of explaining them away?

UBS then mentioned its strict rules to prevent illegal activity. But the so-called Chinese walls which are supposed to exist between the broking, trading and corporate finance arms of investment banks have always been as wateright as a bamboo curtain. Just read the sales puffs put out by supposedly independent research departments before an Initial Public Offering. And do not begin to think about who gets what in the pre-IPO placements, particularly in the case of mainland shares almost guaranteed to double on listing, due either to artificially low pricing or the tiny size of the free float.

The story that first appeared in the Chinese-language 21st Century Business Herald and subsequently in other media quoted unnamed securities industry sources as saying the Swiss bank had profited through alleged insider trading and manipulation of the shares shortly before its China venture helped underwrite PetroChina's public offering in Shanghai.

PetroChina's Shanghai-listed shares more than doubled from the offer price of 16.70 yuan – which was based on the prevailing Hong Kong H-share price – on their first day of trade in early November, hitting 48 before falling back to 31.54 on December 26.

UBS had been a co-sponsor of the Shanghai listing and the Chinese media suggestion is that it used its prior knowledge of the size and pricing of the A listing to load up on millions of H shares and warrants, which rose steeply on the A share issue and pricing news. According to the report, UBS then bailed out, collecting a large profit. The mainland media account claimed UBS had acquired 1.1 billion H shares (of a listing of 21 billion).

If true, UBS could have made a profit of perhaps 25 percent, or HK$4 billion, in the very short space of time it took for the H shares to rise on the back of the A offering. The H shares rose from HK$11.5 in mid-September to HK$19.90 on November 1 before falling back to HK$15 by November 13. Trading immediately after the A listing was exceptionally heavy, with 4.6 billion shares changing hands in just seven trading days.

It would not have been difficult to calculate that a small A share offering – just 2 percent of its shares – would inevitably go to a premium and have a knock-on effect on the price of H-shares. Indeed the small size of the A issue, and the reservation of much of it for insiders, was a license for a few to print money at the expense of the state, as vendor, and small shareholders who could only buy in the secondary market.

Whatever the truth of the mainland media allegation, it highlights the problem of one share being listed in two exchanges operating under quite separate rules. This gives institutions – and alert individuals – a chance to drive a coach and horses through insider-trading and investor-protection regulations.

Whether that is the case with UBS/Petrochina remains to be seen. UBS has certainly been plenty bullish about PetroChina at a time when noted investor Warren Buffet had just cashed out. A recent UBS research report denied claims elsewhere that Chinese oil companies were over-paying for foreign assets in a desperate attempt to gain access to supplies.

But Switzerland’s biggest bank cannot afford more mistakes through over-reaching for quick profits. It recently announced write-downs of $14 billion on sub-prime related assets and had to raise an additional $12 billion in new capital, mostly through sale of a convertible bond representing a 9 percent stake in the bank to Singapore’s Temasek.