* China lets state firms default on derivative contracts- report

* US soy, gold and cotton pressured by report

* Lawyers doubt legal standing of the move

* Market suspects more potential losses prompt the move

* Foreign banks dismayed (Updates with US gold, soy and cotton markets weighed down by reported move; adds analyst quotes, adds CHICAGO to dateline)

By Eadie Chen and Chen Aizhu

BEIJING/CHICAGO, Aug 31 (Reuters) - U.S. gold and soybean markets fell on Monday following a weekend report that China’s state companies may default on commodity derivative contracts with banks providing over-the-counter hedging services.

Traders in other commodities markets in the United States were cautious, underscoring China’s predominance as a buyer in global markets from metals to grain to oil after it played a key role in rallying prices to record highs last year.

In a measure of the country's influence over the global economy, U.S. stocks fell after the Shanghai Composite index .SSEC fell nearly 7 percent to a three-month low on fears Beijing is trying to moderate growth and choke off speculation in its stock market by tightening bank lending.

Commodities markets were chilled by a report in Caijing magazine quoting an unnamed industry source as saying Chinese state-owned companies will be allowed to default on commodity derivative contracts. The report provoked anger and dismay among investment banks that feared a damaging precedent.

China’s regulator of state owned enterprises, the Assets Supervision and Administration Commission (SASAC), has told six foreign banks that SOEs reserved the right to default on contracts, the magazine said in an article published on Saturday.

A government official said that the Bureau of Financial Supervision and Evaluation under SASAC was handling the issue. The official declined to be named and did not elaborate.

“A Chinese agency said they reserve the right to walk away from bad derivatives contracts and that stirred up a lot of worry not only about the stock market but soybeans as well,” said Paul Haugens, vice president at Newedge USA.

China, the world’s top importer of soybeans, has been an aggressive buyer of U.S. supplies, helping drive prices higher as stockpiles fell to the lowest level in over three decades.

US SOY, GOLD MARKETS FALL, COTTON RECOVERS

Chicago Board of Trade soybean futures for November delivery SX9 fell 31-1/2 cents, or 3 percent, to $9.79-1/2.

December gold GCZ9 fell $5.30 to $953.50 an ounce at the New York Mercantile Exchange's COMEX division. U.S. cotton futures fell in early trading due to the news, but closed higher on month-end position squaring.

“Historically, it is not so unusual for China to either renegotiate or abandon some deals that have been made. Some traders who have been around for a while are certainly aware of that possibility,” said Bill O’Neill, managing partner at New Jersey-based LOGIC Advisors.

Spokespersons at Goldman Sachs GS.N, UBS UBSN.VX, JPMorgan JPM.N and Morgan Stanley declined to comment, along with the Securities Industry and Financial Markets Association and International Swaps and Derivatives Association Inc.

The reported letter to the six banks follows an order from SASAC in July that required all state companies trading in derivatives to make quarterly reports about their investments, including details of holdings and performance.

“I won’t be surprised if more state firms emerged with big derivatives trading losses. Or else SASAC won’t come out with such a radical move,” a Hong Kong-based derivatives analyst said.

“As far as I know, there are another number of state firms bogged down in such losses besides those surfaced ones,” said the analyst, who declined to be named due to the sensitivity of the issue.

‘ABNORMAL PRACTICE’

A SASAC media official said he was waiting for the “relevant department’s” official comment before clarifying the situation with the media.

The report deals another blow to investment banks hoping to sell more derivatives hedges in China, the world’s fastest-expanding major economy and top commodities consumer.

“It’s a handful of companies who are being encouraged by regulators to renegotiate. It’s outrageous, but it’s China so everyone is treading very carefully,” said a banking source.

Beijing-based derivatives lawyers said the so-called “legal letter” has no legal standing -- SASAC as a shareholder of SOEs has no business relationship with international banks.

“This can also lead to market chaos. For example, a foreign bank can tell its Chinese clients that it can reserve the right to default on contracts that will bring losses to the bank,” said a lawyer from the derivatives risks committee of the Beijing Lawyers Association.

No bank names were reported in the Caijing report. The SASAC media officer also declined to specify any.

Chinese state firms, especially those that have suffered big losses in derivatives trading, have been complaining that their foreign banks sometimes did not disclose full information of potential risks when selling them complicated products.

For a factbox of China’s derivatives debacles: [ID:nPEK206094] (Reporting by Eadie Chen and Chen Aizhu in Beijing, Alfred Cang in Shanghai, George Chen and Michael Flaherty in Hong Kong, Sam Nelson in Chicago and Carole Vaporean and Steve Eder in New York. Writing by K.T. Arasu, Eadie Chen and Chen Aizhu; editing by Jim Marshall)