The suspicion remains that some Chinese banks financed many times the tonnage that was actually shipped, and didn’t ask too many questions about collateral, provided the loans were repaid on time (even if the banks were repaid out of new loans?).
Having been willing to lend cheap funds against expected copper shipments without retaining the documentation until delivery, or checking that delivery had been made, it was only another step for some banks to lend against faxed or photocopies of physical documentation.
For less scrupulous traders, there seemed to be few controls to prevent loans from several different banks being secured against the same expected copper shipment, before dropping that material back onto the LME and sifting again. Extending the time to arrival also helped reduce borrowing costs, with savvy traders possibly choosing copper at the back of an LME queue, “booked” to China on the slowest boat available.
Estimates vary as to the amount of loans made per Mt of Cu held in China but, with scant audit of physical deliveries against loans, quick turnover of paperwork with original documents not held, and borrowers likely to repeat the scheme to repay maturing loans, it’s not impossible for this Ponzi- style shadow banking scheme to generate more than 10x leverage.
Diapason and Goldman Sachs called out this financing from 2010 onwards, suggesting a curb on the financing would see prices collapse as stocks left China. Market rumours circulated, with stories of warehouses selling financed stocks or pick-ups being attempted with photocopied documentation, and Chinese authorities clamped down on copper financing by summer 2013. Very quickly, some LME warehouses in Asia started showing significant cancellation and re-warranting of nickel and tin, with just a fraction of the tonnages leaving the warehouse.
The issue wasn’t just limited to mainland Chinese banks, lending cheaply against metal “security” which had been pledged multiple times. More conservative western banks were also financing metal onshore in China, using western warehouse companies in turn reliant on local warehouse operators with less rigorous controls.
The problem came to a head in June 2014, after metal was reported missing in Qingdao. The Chinese authorities locked down access to Qingdao’s Dagang storage, and the official word was that any problem was restricted to Qingdao and Shanghai didn’t have an issue. Several western firms were exposed, with Mercuria and Citigroup contesting $270m of financed metal in the English High Court in late 2014-15, and a number of western banks suffered losses.
In the aftermath, construction companies struggled to get financing with PBOC slashing interest rates 4 times between November 2014 and July 2015. Western traders moved metal out of mainland China where possible, and the LME launched LME Shield in 2015, an electronic audit system also available for non-LME warehouses. As late as 2017, Access World revealed that forged warehouse receipts were circulating in Asia, although no metal had been released against those documents.
Four years after Qingdao, the lid remains firmly on the metal financing issue, and it’s not widely known how widespread the problem was for domestic banks. At best, banks lent funds unsecured at a fraction of the risk price. At worst, banks would have faced capital losses if a housing collapse had forced them to fight over collateral that wasn’t there. In contrast to the 2008 global financial crisis, aired publically and still being felt 10 years later, China’s shadow banking issue has avoided the spotlight.
Rohan Ziegelaar E:
metals.desk@
admisi.com T: +44(0) 20 7716 8081
17 | ADMISI - The Ghost In The Machine | November/December 2018
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