QINGDAO 2.0??
In a previous Ghost article, “Slow Boat to China” (Nov-Dec 2018), we discussed how a Chinese Government clampdown on lending to the rampant construction sector in 2010 encouraged some Chinese builders to explore alternative sources of funding, specifically metals transit finance.
Back then, unsecured domestic lending was perhaps 10% p.a., but some domestic Chinese banks were offering attractive rates of sub 4% when “secured” against imported metal shipments (typically copper), a US$ denominated asset.
The raw material departments of some construction companies would buy and cancel LME copper warrants, showing the warehouse receipts to the lending bank, and receive them back within a couple of weeks together with funds lent to a future date supposedly coinciding with the metals arrival / use in mainland China (warehouse receipts are created when LME metal warrants are picked up and cancelled, ahead of being shipping out).
Unscrupulous borrowers realised that they didn’t need to hold the warehouse receipts for the term of the loan, given that banks were lending on sight of documents (including faxed/photocopied documents), so they could avoid the expensive LME cost of carry by re-warranting the metal to LME, and then repeat the process of picking up and cancelling different warrants to generate fresh warehouse receipts.
It’s possible that some borrowers would send the same warehouse receipts to several banks at once, thereby multiplying the funding. The lack of a central registry of collateral made it impossible to know the extent of multiple pledging against total metal held, but estimates at the time varied from 10x, 20x or even 50x lending against metal held?
MARKET CONTINUES TO SEE WARRANT TRADING ENQUIRIES FROM NON-PHYSICAL PLAYERS IN ASIA.
Provided that the funds were re-paid on time, it seems the lenders did little checking against the collateral used as security, and it’s possible that earlier loans were repaid out of funds received against new finance deals.
Warrant traders may have questioned why these customers were picking up and dropping back warrants in a pointless and costly merry go round, paying bid/offer spreads, financing, rent and re- warranting costs without actually shipping metal, even specifying metal at the back of a queue and a slow boat to China to extend the loan maturity.
The Chinese govt clamped down on copper warrant financing in mid-2013, but a similar pattern of cancellation / re-warranting quickly emerged in zinc, nickel and tin.
20 | ADMISI - The Ghost In The Machine | Q3 Edition 2021
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