Updated, 8:45 p.m. | Large banks and trading firms are frantically trying to determine whether they have fallen victim to a suspected commodities fraud emanating from the giant Qingdao Port in northeast China.
Citigroup and several other big Western banks are concerned that their loans may lack the appropriate collateral of big stockpiles of copper and aluminum at the port. The banks have inspectors on the ground who are trying to assess whether enough of the metals are there.
The worry stems from suspicions that a Chinese company pledged the same collateral for multiple loans. Chinese authorities are investigating the matter.
The case could have broad repercussions for the commodities market and the Chinese economy. Banks have funneled billions of dollars into the Chinese economy through these murky transactions, and commodities prices have been falling over concerns that the lending will dry up.
Western banks, including Citigroup, are bracing for any potential fallout.
Just months ago, Citigroup fell victim to a multimillion-dollar fraud in Mexico. If the Qingdao developments hurt the bank, regulators and shareholders are likely to press it to explain why its controls failed again.
Chinese companies are at risk, too.
Citic Resources, part of the state-controlled conglomerate Citic Group, plunged nearly 10 percent on Tuesday after it disclosed that it might be affected by an investigation into stockpiles of metals held at the port. The shares recovered on Wednesday.
The potential fraud is linked to an opaque corner of China’s financial system that has grown substantially in recent years, bringing huge amounts of capital into the country. Many Chinese companies and investors, struggling to secure traditional loans from the state-dominated banking sector, have instead turned to alternative, unregulated financing methods involving imports of materials like copper, aluminum and iron ore.
These commodities financing deals are part of a growing number of nontraditional lending activities that have pushed credit in China to levels that are raising fears among investors and analysts. Jonathan Cornish, the head of North Asia bank ratings at Fitch Ratings, estimates that total outstanding credit in China rose to more than 220 percent of gross domestic product last year, up from 130 percent in 2008.
A typical commodities financing deal works like this: Copper is imported using letters of credit, warehoused in duty-free zones and pledged as collateral for cheap bank loans. The loan proceeds are used by the importer to speculate in higher-yielding, short-term investments. When the letter of credit comes due, the importer then either sells the commodity or the investment product.
One such importer in Qingdao has drawn particular scrutiny. Last Friday, Qingdao Port International, the biggest port operator in the Chinese city, announced that the authorities had begun investigating a suspected fraud related to the aluminum and copper stored in its warehouses. A day earlier, a report in The 21st Century Business Herald, a Chinese-language newspaper, identified the company under investigation as Decheng Mining.
The report said Decheng Mining was suspected by the authorities of having pledged the same stocks of the metals — about 100,000 tons of aluminum and 2,000 to 3,000 tons of copper — as collateral for multiple loans, amassing bank debt exceeding 1 billion renminbi ($160 million). Phone calls and emails to Decheng’s parent company, Dezheng Resources, went unanswered on Wednesday.
The figures in the Decheng case are not huge compared with China’s overall imports of commodities. But the concern is that such schemes may be broader, involving more than just one company at one port.
While Shanghai is China’s main port for the importing of metals like copper, volumes in Qingdao are substantial. Qingdao’s port ranks as the country’s fifth-largest in terms of cargo handled, with around 12 percent of China’s metal ore and 15 percent of crude oil shipments by volume, according to Qingdao Port International. But the trade there may not be regulated to the extent that it is in Shanghai, where the Shanghai Futures Exchange maintains its official copper warehouses.
Shares in Qingdao Port are down around 4 percent from their Hong Kong trading debut last week. The company has said that business is continuing as normal and the metal stockpiles subject to the investigation “account for an immaterial proportion of the total annual throughput of the group.”
The banks and trading companies have sent inspectors to the port to try to assess the size of the stockpiles. But the port operator was not giving them access until its own officials have done their inspection, according to a person briefed on the situation at the port who was not authorized to speak publicly on the matter.
If wider fraud is unearthed, banks will probably have to scale back their commodities-related lending in China. That in turn could cause the prices of certain metals to drop and lead to a decline in credit in the Chinese economy. Goldman Sachs estimates that as much as $160 billion has flowed into China through commodities-backed loans since 2010.
As Citigroup assesses any damage, it is zeroing in on commodities loans to the Mercuria Energy Group, a Swiss commodities trading firm. Citigroup lent money to Mercuria secured with copper and aluminum apparently stored in Qingdao.
On May 28, Mercuria informed Citigroup that improprieties might have taken place at the metals warehouses, according to a person briefed on the loans who spoke on condition of anonymity. If Mercuria borrowed the money on the basis of nonexistent commodities, Citigroup could have the right to demand that Mercuria repay the loan. If Mercuria did that, Citigroup would probably not suffer a significant loss. Mercuria declined to comment.
“Citi is aware of reports of issues at the Qingdao port in China,” Danielle Romero-Apsilos, a Citigroup spokeswoman, said in an emailed statement. “To the extent Citi’s clients are affected, Citi will work closely with the relevant authorities, warehousing companies and clients to resolve the matter.”
The situation in Qingdao could have uncomfortable parallels for Citigroup.
Loan collateral was the underlying problem in the Mexican fraud involving a Citigroup subsidiary, Banamex. In that case, the bank discovered that as much as $400 million of assets pledged to Citigroup did not exist.
The bank also suffered a setback this year after it failed a crucial regulatory stress test. As a result, the government did not approve its plans to increase dividends and stock buybacks.
If the bank were to lose money from its Chinese commodities loans, it would deepen concerns that Citigroup cannot properly monitor its sprawling operations across the globe.
Other large Western banks are active in the metals-backed lending in China, including Standard Chartered, BNP Paribas, Natixis and ABN Amro.
“We recognize that there are currently issues in China around commodity financing, which we are monitoring,” Tan Hsueh Mei, a spokeswoman for Standard Chartered, said in an emailed statement. “We are working closely with our clients. However, as investigations are ongoing, we are not able to comment further.”
Standard Bank, a South African lender, said in an announcement last Thursday that it had “commenced investigations into potential irregularities at the port” in Qingdao, and that it would “be working with the local authorities as part of its investigations.” The bank, which is 20 percent owned by the Industrial and Commercial Bank of China, said its commodities trading business was carried out by its London subsidiary, a unit that is 60 percent owned by Industrial and Commercial Bank of China.
