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Missing Collateral a Sign of Weakness in China’s Financing Chains

Missing Collateral a Sign of Weakness in China’s Financing Chains

By JOHN FOLEY

JUNE 12, 2014 12:21 PM 1 Comments

Faith in metal-backed lending in China is corroding – and so is confidence in the country’s giant credit system. Authorities and banks, including Standard Chartered and Citic, are investigating whether traders at Qingdao port used the same lot of copper and aluminum to back multiple loans. Vanishing collateral isn’t a new problem, but could prove to be China’s weakest link.

Lending backed by warehouse receipts is common and helpful, and not just in China. Often, a bank will buy metal in the form of a document showing ownership, with a pledge to sell it back after six months. In hard-asset fixated China, this has morphed from a way of facilitating trade to a method of obtaining speculative finance. Fraud can result when records are out of date or papers fake, as seems to have happened in Qingdao.

The direct damage looks manageable. Copper tied up in questionable trades in Qingdao may amount to 20,000 tonnes – that’s about $140 million at spot market prices. Traders are moving their shipments to other ports that are considered to be better regulated. Some banks may have to write off debts, or mark them up as riskier. But assuming these lenders still want China to treat them favorably, they are unlikely to protest too much about poor controls, or sharply pull back credit.

Imaginary collateral, though, is a deeper problem. Steel traders also backed multiple loans with the same piles of metal in 2012. In a different riff on the same theme, the timber company Sino-Forest came under attack in 2011 from short-sellers for fabricating the trees that made up its main asset. Foreign banks can find themselves exposed because cargo owners use collateral to obtain cheaper overseas loans, and invest at higher returns in China. The problems in Qingdao suggest the banks have failed to learn their lesson.

China can just about manage without foreign lenders, but it can’t do without collateral and confidence. These underpin the explosion in nonbank lending, including trusts and investment products sold to individuals, which has now reached around two-thirds of gross domestic product, according to estimates from Barclays. Copper and aluminum are transparently priced and easily traded, the same isn’t true of coal mines, houses or shopping centers. If supposedly sophisticated banks can get caught out, the rest should be nervous.

 

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About bambooinnovator
KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing. KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund. Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options. All articles in the website reflect the personal opinions of the writer.

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