Fraud effect lingers on metals financing market

Companies face greater scrutiny and lower levels of financing

Anyone even marginally involved in commodities will be aware that last year's Qingdao port incident had an immense impact on the worldwide financing trade for metals. More than a year after the discovery of large-scale collateral fraud involving warehouse receipts for metal stored at Qingdao port in Shandong province, which had been pledged multiple times as collateral to raise finance, Chinese and international banks continue to take a dim view of lending to the copper industry, and the metals sector as a whole.

How those warrants or warehouse receipts were faked and financed is another matter, but there is no doubt that almost everyone involved, including the companies that suffered losses, were part of various metals-financing chains. Banks have dramatically curbed their appetite for lending, offering lower loans against collateral and cutting credit lines, resulting in many smaller Chinese industrial companies being starved of cash. Even companies conducting legitimate deals have found themselves in the spotlight of scrutiny from financial lenders and struggling to obtain financing for commodity transactions.

In the aftermath of the scandal, both international and domestic banks have become reluctant to enter into new transactions involving funding projects that relate to Chinese-associated metals. Following the sudden withdrawal of credit to Shandong's industrial base, local governments have now become involved in the administration of credit by state-owned banks. They regularly inspect the accounts of industrial companies in an attempt to improve the situation.

As long as the banks provided the financing support to sustain liquidity levels in the market, the underlying metal prices were not adversely affected. Once the banks took the decision to pull out, these metal inventory positions, being used as derivative tools to refinance deals, became distressed. The resulting demise of metal prices, copper, has dropped to levels last seen in 2009 ($5,240 on July 24) and many expect this situation will worsen before we see any sign of improvement. A concern over the economic outlook for China has grown as more than 1,000 companies have suspended trading in their shares, equating to more than half of China's listed companies. To rebuild the confidence needed to make a difference will inevitably take time and will demand processes are improved.

For China to retain its dominant global position across the base metals, steel and recycling markets, it is essential that companies can obtain the necessary financial liquidity to support this dynamic growth market. In the wake of the restrictions, financing counterparties have implemented stringent regulatory requirements, insisting on watertight documentation, much higher collateral and full transparency from their potential partners.

Although the regulators are becoming aware of where the weaknesses in the system may be and are considering corrective measures to instigate change, it will take time before everything in China can be put back on the right track. While there is no guaranteed method of preventing such fraud in the future, we do need to return to more normal financing conditions, whereby businesses are supported and are able to achieve further growth. Only by being able to provide an investor or financial institution with total transparency and material traceability throughout the lifecycle of the deal will there be any opportunity to secure these necessary levels of financing.

Since 1985 Brady Plc has been providing companies with answers, tracking and valuing the full lifecycle of the commodity from raw material, concentrate, refined metal to finished product. This includes inventory management, risk exposure and management, warehousing solutions, collateral management, credit limits, margining, through to document management and fully integrated accounting solutions.

The author is head of global marketing at Brady, a London-head quartered trading and risk management software solutions firm. The views do not necessarily reflect those of China Daily.