Banks are sceptical of and reluctant to lend to the commodities trade in China, due to the downturn in price and the risk of fraud and default.
Over the course of a day-long conference in Beijing, commodity traders, bankers and lawyers all signalled that banks have been forced to re-evaluate their lending practices in China. While many banks have been scaling back on commodities lending globally, the situation is aggravated in China, where a number of high-profile fraud and document-keeping scandals have ebbed away at trust in the sector.
It’s led to consolidation in the market, where banks are focusing on their core business, leaving fewer willing to dabble in perceived higher-risk markets, and leaving producers and traders scrambling for the little finance available to them.
“All financial institutions are sceptical on commodities,” said Calvin Leung, head of trade, North East Asia at National Australia Bank. “There’s a lot of bad practice in the market.”
He added that the practice of using a single instance of commodity collateral to obtain multiple loans has also come under scrutiny. “Banks are getting more concerned about using the commodity to finance… If a bank wants to focus on commodity finance it requires another set of expertise. Some banks have got burnt and withdrawn from the market.”
More than a year on from the Qingdao metals fraud at the world’s seventh-largest port, the topic is still causing confusion and concern throughout the sector in China. It has slowed the pace and volume of transactions, but has forced banks to become more granular in their approach to China.
“In the past, Chinese banks didn’t care about fraud – just the paperwork,” admitted Zhang Zhaojie, head of trade service and financial institute at the Agricultural Bank of China.
Metals and mining are in difficult financial predicaments. Banks don’t want to lend, and they can’t go to equity markets. John Reeve, AgRee Commodities
Now, the feeling is that banks are becoming more diligent in their approach, particularly to warehouse financing and repurchasing agreements (repos).
“I think the Qingdao scandal tells us we need to do more due diligence in terms of the local legal system. For example, on Qingdao the issue is the warehouse receipt. As we know in China a warehouse receipt is not the document title,” Yongmei Cai Evers, Partner at Simmons & Simmons told GTR.
The product of all this is the creation of a gap in the financing market. GTR has reported throughout 2015 of the growing presence of hedge funds and private equity firms in the commodity finance space in China. Much of this financing is done on a cross-border basis out of Hong Kong.
“Metals and mining are in difficult financial predicaments. Banks don’t want to lend, and they can’t go to equity markets,” said John Reeve, director at Brisbane-based AgRee Commodities. “The private equity space is looking to dovetail into mining pre-payments.”
These firms are believed to be looking to make money through mining royalties or streaming – when a funder makes an agreement with a mining company to purchase all or part of their precious metals production at a low, fixed, predetermined price to which both parties agree. In some instances, the fund may take a 20 to 30% stake in the lifetime of a mine, providing a genuine alternative to a banking sector that’s conspicuous by its absence.