There has been considerable commentary about metals financing concerns in China, especially involving aluminum and copper in warehouses – indeed, one article in the FT leads with exactly that title.
The nub of the problem is that funds secured from long-dated letters of credit issued for the import of certain commodities and collateralized on the value of those commodities has been used to make loans at higher interest rates to organizations that could not normally borrow at commercial rates from the banks. (Here’s David Gustin’s take, on our sister site Trade Financing Matters.)
In addition, it is believed that funds have been used for interest rate arbitrage, for renminbi speculation, and (here is the worrying part) the commodities involved have in some situations been borrowed on more than once.
The specific case that hit the headlines is of a firm called Decheng Mining which, it is alleged has borrowed multiple times on the same parcel of metal held in the port of Qingdao. The Communist Party Committee of Qingdao Port is investigating the case, but the fear (and amongst the trade, the belief) is that the practice is not confined to just Decheng, but is in fact widespread.
Foreign banks no doubt fear the same, as London-based Standard Bank of South Africa and Standard Chartered Bank have both withdrawn trade financing from the region until they can establish the extent of the problem. The FT reported that last year the collapse of a steel trader in East China revealed that the steel had been pledged multiple times in order to borrow more money, so clearly Decheng is not an isolated incident.
How Much Copper, Aluminum Are We Talking?
The FT says about 3,000 tons of copper and 100,000 tons of aluminum have been pledged multiple times in Qingdao, according to traders and Chinese sources. However, Macquarie Bank put the pledged amount much higher, at 20,000 tons of copper; and Andy Home at Reuters speculated the number is probably higher still. As Home puts it, there is around 700,000 tons of copper sitting in the Shanghai bonded warehouse zone, give or take 100,000 tons.
It’s hard to say, since this metal is not registered with any exchange and exists in the statistical twilight (as, it would seem, does its true ownership). But everyone agrees it is the single-largest concentration of refined copper anywhere in the world. It dwarfs the combined tonnage registered with the world’s main three copper-trading exchanges – the London Metal Exchange (LME), COMEX in the U.S. and the Shanghai Futures Exchange in China itself.
Much of it, probably most of it, is being used not for any manufacturing purpose, but as collateral for lending and, often, re-lending. Nor is the problem restricted to copper: there is 104 million tons of iron ore sitting in Chinese ports, some of which has been used for this exact purpose. Indeed, iron ore imports have remained robust even as steel demand has weakened, leaving one to speculate some of the demand is for financing deals, not steel production.
Should We Worry About This?
Surely, it is an internal Chinese matter; if a few Western banks have got themselves caught up in it and get burned as the clients default, the underlying commodity proves to not be there or pledged elsewhere, well, some may say, that’s their fault for lending in such an unregulated market.
But yes – we should be worried on a number of levels.