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Commodity finance in China: An assay-light strategy; A fraud investigation casts a shadow over China’s metal imports

Commodity finance in China: An assay-light strategy; A fraud investigation casts a shadow over China’s metal imports

Jun 14th 2014 | From the print edition

AT THE best of times, seizing collateral on defaulted loans in China is a fraught task, plagued by patchy enforcement. These are not the best of times in the port of Qingdao, a trading hub in the north-east. Police are investigating whether companies have committed fraud by pledging the same holdings of copper and aluminium to multiple banks, multiple times. The banks are scrambling to see how much of the metal sitting in Qingdao’s warehouses actually belongs to them.

More than just a fraud, the tale exposes China’s financial idiosyncrasies and the lengths to which firms sometimes go to borrow money. Regulators have tried to choke off credit to metal traders in recent years as part of efforts to slow pell-mell construction. Traders have devised a simple workaround. Banks have been willing to grant them letters of credit to fund purchases of metal. The traders have used the credit to buy some and then, on occasion, immediately resell it, leaving them with cash to invest in high-yielding shadow-bank products.

This ruse can earn enticing returns. The gap between the traders’ investment returns and their funding costs can reach ten percentage points. And that is before fraud enters the picture. By obtaining letters of credit from different banks to buy the same copper again and again, traders amplify their returns.

The crucial ingredient in this deceit is a receipt of ownership issued by the warehouse where the metal sits. The 21st Century Business Herald, a Chinese newspaper, said receipts tied to the same stash of metal had been issued ten times.

Financial alchemy of this kind is common on the margins of China’s banking system. But in this case, it comes with global connections. First, there is China’s demand for commodities. The Qingdao investigation will make banks more reluctant to grant letters of credit, even when legitimate, hampering imports and so weighing on prices. Second, foreign banks have been big issuers of letters of credit to Chinese metals traders. Goldman Sachs estimates that commodity-backed deals account for as much as $160 billion, or about 30%, of China’s short-term foreign-exchange borrowing. Only a tiny sliver of that is believed to be at risk in Qingdao, but foreign creditors may become more skittish. Call it collateral damage.

 

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About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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