SLOW BOAT TO CHINA...


Copper has many uses in construction, from electrical to plumbing to heating to roofing, but its role as a funding vehicle really came to the fore after China introduced a round of macro controls to counter the rapid rise in house prices in 2009-2010. Bank lending to the housing industry peaked above RMB 2 trillion in 2010 (6.83RMB =$1 in late 2009), falling towards RMB 1.3 trillion in 2011 and 2012, and the industry tried to make up the shortfall.


Facing restrictions on bank lending, developers found that domestic banks would finance inventory at preferential rates, including LME metal on route to Chinese ports. As a US$ denominated asset, this “secured” lending might cost 3-4% compared to 9-10% for domestic lending to the building sector.


Rather than being solely focused on acquiring and hedging building materials, the commodity trading units of some Chinese construction companies grew into significant funding vehicles for their parent companies, using schemes maybe similar to the following example:


• LME warrants were bought and cancelled, and the buyer would show the resulting warehouse receipt to a mainland Chinese bank as proof of ownership of a US$ denominated physical asset heading for China.


• After a credit process lasting perhaps 2 weeks, the bank would give transit financing at cheap rates. The banks would then return the warehouse receipt (i.e. the “security”) to the buyer along with the funds, and the financing term would reflect the expected delivery time to the Chinese port.


• With the warrant buyer now holding the funds and the warehouse receipt, there was little to stop them from re-warranting the stocks back onto the LME, and then sifting for new warrants before applying for another round of financing.


• The cost to do this would be the LME sift and cost of carry for a couple of weeks until re-warranting plus, perhaps $5/Mt for re- warranting charges minus any contango.


Table 1: Possible example of a transit finance trade


TRANSIT FINANCE DEAL COPPER PRICE MT


VALUE # MONTHS


FUNDING COST AT "SECURED RATE" PLUS LME COSTS (SEE BELOW) TOTAL FUNDING COSTS


EFFECTIVE FUNDING RATE %/YR c.f . FUNDING A FUNDING COST SA


T DOMESTIC RA VED


TE


EXAMPLE: POSSIBLE LME COSTS 2WEEKS FUNDING RENT $/DAY/MT


COMMISSION 1/16% RE-WARRANT $/MT LESS LME CONTANGO LME COSTS Source: ADMISI


$8,000 10,000


$80,000,000 7 3.0%


$1,400,000 $210,000


$1,610,000 3.45%


10.0% $4,666,667 $3,056,667


2.25% $0.50


0.0625% $5.00 $3.00


$70,000 $70,000 $50,000 $50,000 -$30,000 $210,000


FACING RESTRICTIONS ON BANK LENDING, DEVELOPERS FOUND THAT DOMESTIC BANKS WOULD FINANCE INVENTORY AT PREFERENTIAL RATES, INCLUDING LME METAL ON ROUTE TO CHINESE PORTS.


16 | ADMISI - The Ghost In The Machine | November/December 2018


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