Citi Mercuria Lawsuit to Rattle Commodity Trade Finance Landscape

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A rather significant legal case involving a major US bank (Citi), a metals trading company, and phony warehouse receipts could alter the way that goods move throughout the world via the repo market. The case could be decided any day.

The potential cost to banks, both in China and elsewhere: over $4 billion.

The dispute is about a deal involving metal-backed loans – $270 million worth – that Citi lent to Mercuria against metal held in Qingdao and Penglai ports in China. The implications seem clear, according to industry sources as reported by Global Trade Review, banks could tighten lending requirements and criteria and that means it will take longer to get deals done.

Click to see how iron ore shippers cut international trade working capital.

My colleague, Stuart Burns, penned a comprehensive analysis of the case back in December.

“Banks have already tightened up loan arrangements around metal financing and if [the case] goes against Citi, another round of reviews could tighten commodity trade finance even more,” according to Burns.

According to Linos Choo, a litigator at law firm DLA Piper, in a quote from the Global Trade Review piece, “what is clear is that the case had led to a surge of metal leaving Qingdao and other Chinese ports to ‘safe haven’ destinations.”

In addition, zinc and nickel may be the two most impacted metals markets, according to Choo, with Korea and Malaysia gaining the most as material has moved to LME warehouses based in those countries.

We asked Stuart Burns for some additional insight regarding the potential impact of the ruling.

How courts will likely decide Citi-Mercuria case:

It’s tough to make a call, there’s a lot of devil in the detail. How will the court view the terms of the contract? Personally my money is on Citi, because although Mercuria is claiming that title passes to the bank under these obligated repo deals, I don’t personally see that as the intent –the intent was the commodity only sits there as surety in the event the trader doesn’t pay back the money. If the value of the asset comes into doubt (for example, if it doesn’t actually exist, sarcasm intended), the responsibility to repay remains with the trader or borrower, in this case Mercuria. But when the debt is $270 million, you can see why they would argue otherwise.

And the long-term impact on commodity trade finance…

It is already having the impact of reducing trade finance, at least for this kind of commodity trade. Banks are becoming more cautious about who they will lend to and what they require in terms of security. Metal has flowed out of third-party warehouses in China into the LME system, which is deemed to be better controlled than independent operators.

See how large metal traders have cut shipping costs with trade automation.

Moreover, metal has left China destined for other Asian jurisdictions where legal cover and operating procedures are considered more robust such as Korea, Singapore and Malaysia. When the dust settles, I think it will encourage banks to look more favorably at embracing electronic systems. Paper-based title and transaction processes served well enough when there was nothing better, but in a digital world there are more secure, quicker and less costly ways of handling transactions that will increasingly appeal to banks. For trade finance, it’s come at a bad time as banks generally have drawn back from the commodity-financing arena as margins and volumes have shrunk.

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