Recent developments in metals fraud cases have signposted routes for a bank to take “when it suddenly finds out that it is not actually holding the collateral it thought it held”, says a lawyer who has advised on similar cases.

In the latest update in the most recent nickel fraud case to rock the commodity trading world, broker ED&F Man has filed a US$284mn lawsuit against two Hong Kong companies, alleging that they knowingly provided fraudulent warehouse receipts for nickel stored in Asia.

The case, which became apparent in 2017 when ANZ filed court proceedings in California, involves a repo deal between ED&F Man and the bank, whereby ANZ was buying a consignment of nickel. ED&F Man had purchased the nickel on back-to-back terms from two Hong Kong-based companies called Come Harvest and Mega Wealth, paying them a reported US$117.3mn and US$167.2mn respectively.

These were non-obligated repos, meaning neither ED&F Man nor the two Hong Kong companies were obligated to buy them back. The total amount of nickel was reportedly more than 30,000 tonnes.

The 31 purchase contracts between ED&F Man and ANZ were the subject of 84 warehouse receipts, purportedly issued by Access World, the metals warehousing arm of commodity trader Glencore. The receipts were first issued to a Singapore company called Straits, who subsequently endorsed them to Come Harvest and Mega Wealth. As the metal was sold on to ED&F Man, the warehouse receipts were endorsed again. This happened again when the receipts were endorsed to ANZ.

ED&F Man discovered that there was a problem with the authenticity of the warehouse receipts, at which point it told ANZ that it would not be buying them back. ANZ was at this point holding 84 receipts, which it brought to Access World, asking them to put the nickel on warrant to sell. At this stage, Access World saw that 83 of the receipts were fake and refused to accept them.

The case shares features with another metals fraud scandal, this time involving French bank Natixis. In a trial being held at London’s High Court, it is currently suing metals broker Marex Spectron for US$32mn, claiming to have lost the money in a fraud involving fake warehouse receipts at Access World warehouses. In both cases, Come Harvest had allegedly provided the warehouse receipts that later turned out to be forgeries.

All of this raises the spectre of the Qingdao metals warehousing scandal, in which metals trader Dezheng Resources produced fake warehouse receipts or fake certificates for aluminium ingots, alumina and refined copper at the eastern Chinese ports of Qingdao and Penglai. This led to combined international losses thought to run in excess of US$1bn, and saw the chairman of the company recently sentenced to 23 years in prison.

A point of note about the ANZ/ED&F Man and the Natixis/Marex Spectron cases is the divergent legal pathways the complainants have taken to recoup their losses. Natixis chose to sue its immediate counterparty – in this case, Marex – and force them to go down the chain to find out who is ultimately liable. Meanwhile, in its suit, ANZ vowed to pursue causes of action against “fraudsters, once their identities are known”, with counterparty ED&F Man now taking action.

Which approach presents the best chance of success remains to be seen, however the upshot of these metals fraud cases is that banks are going to be looking increasingly closely at the terms of their commodity trading contracts, says Dorothy Murray, partner at law firm King & Wood Mallesons. While the firm does not have a formal role in either of the two cases, it has been involved in a number of similar metals fraud issues, and has assisted clients in relation to the Qingdao case. Speaking to GTR, Murray explains the legal implications of the ongoing cases, and highlights what banks can do to protect themselves.


GTR: What is behind the different legal approaches in the ANZ/ED&F Man case and the Natixis/Marex Spectron case?

Murray: What struck us about the cases is how they model so well the two key things a bank can do when it suddenly finds out that it is not actually holding the collateral it thought it held. You can either sue your immediate contractual counterparty and leave it to them to go further down the chain, which is what Natixis is doing against Marex, or you can do what ANZ are doing, which is not to sue your immediate counterparty, and to go after the ultimate fraudsters. We have also seen people do both in parallel.

In terms of what could be driving ANZ’s approach, strategy is going to be dictated by the terms of the particular repos or whatever finance contracts are in play. Do they make it clear beyond doubt who is liable? Who is essentially left holding the baby? With Natixis and Marex, Natixis are not saying that Marex as the broker forged the documents; they’re just saying that Marex are liable to them under the terms of their deal for the receipts being forged and it’s for Marex to go further down the chain.

Strategy is also going to be driven by exactly what due diligence and internal processes a bank applied to the deals and its appetite to publicise its processes. Having seen other banks and brokers have to explain every detail of their internal process in public proceedings, ANZ may simply prefer a more prudent approach and to keep its confidential business confidential.

Then there is the matter of maximising cost-efficient recovery: who is actually going to compensate you for the full amount of your losses? Pursuing the end fraudster is usually more difficult; you have to expend a lot more time and cost up front in tracing funds and getting freezing orders, in going not just to the companies involved, because it’s very unlikely any cash will still be there, but also pursuing that cash into other jurisdictions. It may well be that ANZ has decided that it has a better chance of greater ultimate recovery from its route even though it probably involves more upfront costs and effort than going after ED&F.

A further point – and probably the key one in ANZ’s approach – is the ongoing commercial relationship. I don’t know what ED&F and ANZ do together and the wider picture. However, sometimes it’s just not politic or possible to sue one of your key clients or counterparties; it can be better to work together to go after the real wrongdoers so that no one ends up out of pocket.


GTR: How can banks do better in protecting themselves against metals fraud?

Murray: Banks are going to be looking internally to check that they have quite clear protections against their counterparty.

Firstly, you need to make the decision about what you really want. Do you want a right against your counterparty? Because then your focus is on the contractual terms. Lots of these have been in circulation for years and have been well tested. I think people will have looked at them in light of Qingdao, so any drafting improvements have probably been made already in current deal terms. We’ve got to remember though that the terms being considered here are going to be historic ones.

You must also make sure you know and record what due diligence you have done on your counterparty, and what due diligence they have done. As I understand Marex’s defence, they said that even if the receipts are forgeries, they are not liable because they took all the appropriate steps to authenticate them with Access World. It’s unclear from the pleadings we have seen whether Natixis knew at the time exactly what Marex had done. So, even if you’ve got well-drafted contractual protections, you need to be alive to the sort of defences that could be raised against you and make sure you’ve got knowledge of the relevant facts behind them. I think that’s something banks are going to be a bit more alert to.

Secondly, if what you really want is ultimately the metal, your focus then is going to be on the warehouse receipts: making sure that there is an act of attornment, that the warehouse receipts are cancelled and then reissued directly to you. If you are a bank which is in a position to take physical control of the metal – and not all banks are or want to be – your focus should be on making sure that you have an original warehouse receipt in your hand from the true warehouse operator. I say ‘true’ because something that came out in the facts about Qingdao is that a lot of international counterparties were dealing with highly reputable international collateral managers who had legitimate back-to-back agreements with local warehouse operators, but it was probably at this local level where the forgery was happening. As a result, you need to pick all the way through the chain to make sure you’ve got that bit of paper from the guy who’s actually controlling the metal and will be the one to give you possession.


GTR: How can the metals warehousing business regain trust amid these fraud cases?

Murray: We’re not hearing about any hesitance to get involved in repos per se. And of course the majority of deals are not tainted by fraud – it is simply business as usual. A lot of banks and market players are trying to look for a solution to this, and that involves trying to move from paper to technology. Essentially, if you were setting up an industry of this size today, would you start with paper? It is labour-intensive, costly, it takes lots of middlemen to police, and it has been shown to be forgeable to a level to fool even very sophisticated parties. Whatever criticisms there are of various distributed ledger technologies, those criticisms are minor compared to how you would assess paper if you were starting from scratch. We’ve seen a lot of interest from all our commodities clients to explore what they can do to improve the transparency and traceability of their supply and financing chains. It’s a bit of a race; lots of people are setting up their own schemes. But until China adopts – or rather mandates – a solution, no solution is going to work. I wouldn’t be surprised if we saw some indication from China in the next year or so that this is going to happen.