China's "Evaporated" Collateral Scandal Spreads To Second Port

Tyler Durden's picture

Starting back in May of 2013, we first predicted that China's "Lehman event", even more troubling than the recent advent of Chinese corporate bankruptcies and perhaps even its housing crisis, namely the "discovery" that behind China's virtually-infinite rehypothecation machine - the backbone of its shadow funding markets - the amount of actual physical commodities is severely limited and misrepresented, meaning that for every paper claim on an underlying "funding" metal, there are pennies on the dollar, or renminbi as the case may be, of actual underlying collateral. Or, as MF Global's Jon Corzine may say, "it evaporated." A year later, this too prediction has come true, and overnight none other than Goldman laid out a checklist of just how the recent revelation that not all bonded warehouses at the port of Qingdao, China's third largest, will become the catalyst to further CCFD unwinding.

And while this story is very slow to gain prominent media coverage for obvious reasons, the few outlets that have been keeping up, continue to disclose ever more troubling details, of which the latest and greatest one is not that China's key bank, state-owned Citic Resources has moved to secure the metals (it hopes) it has possession of at Qingdao: this was perfectly expected and the only question was who would be the first counterparty to admit there is a massive rehypothecation problem, and will be the second leg in the crisis, as one claimant after another rushed for their physical only to find that it has been pledged a countless number of times to other counterparties.

No, the biggest news was that the troubles at Qingdao, which as noted is merely the 3rd largest Chinese port, have now spread to a second Chinese port: Penglai, which is also located in the Shandong province. Putting some size numbers for context: Qingdao's copper inventory is about 50,000 tons, compared to 800,000 tons in Shanghai, analysts say. There's "little evidence" for now that traders in Shanghai fraudulently have pledged collateral to banks, said Sijin Cheng, an analyst with Barclays Research in Singapore. Little evidence will become "lots" in the coming days when we expect more "discoveries" at all other bonded warehouses as the relentless inflow of commodities finally reverses and the beneficiaries finally demand possession. As everyone who has followed even the simplest Ponzi schemes knows, this is the part of the lifecycle when many tears are shed by most.

Here is what else the WSJ had to say on this topic:

The trading firms hold the deed to the metal, which can be used to secure financing, but the metal stays in a warehouse. Banks fear a private Chinese company may have used the metal as collateral to get multiple loans, potentially defrauding the lenders and trading firms.


These banks have not been able to get access to the collateral, stored at Qingdao Port, which administers the warehouses.


In an announcement to the Hong Kong stock exchange, Citic Resources said it has applied to courts in Qingdao for "sequestration orders in respect of the Group's alumina and copper." It said it owns alumina and copper stored in bonded warehouses at the port.


A number of Western and Chinese banks have sought similar court orders in an effort to secure their collateral, according to one person familiar with the matter. But the court orders won't alleviate the problem of multiple lenders claiming the same piece of collateral that had been promised to them by the borrower, this person said.

Meanwhile, the infinite rehypothecation bug has gone airborne:

Western lenders are also concerned that the potential fraud may also have occurred at Penglai port, located about 150 miles south of Qingdao, according to people familiar with the matter. Inspectors have been unable to again access to collateral stored at Penglai port, one of the people said.


One executive at a Western bank said the development is a worrying signal that the possible fraud first uncovered at Qingdao may be more widespread than anticipated.

The banks involved:

The Western lenders involved include Citigroup Inc., Standard Chartered PLC, Standard Bank PLC, ABN Amro Bank NV, BNP Paribas SA and Natixis.

Not surprisingly, Citic, which as noted above was the first bank to defect from the group of ostriches with their heads in the sand is quiet about what it finds: the last thing it wants is other banks to scramble and obtain their collateral at a time when Citic is doing the same. Good luck getting your copper, aluminum... or gold... after the first one or two banks have recovered their deliverables: there will be nothing left for anyone.

Citic said the status of the investigation by authorities is "unknown" to the company and that it cannot provide further information on the effect of the investigation on its alumina and copper assets.


For about a decade, Chinese and Western banks have facilitated the flow of capital into China backed by imported commodities. More recently there has been concern that Chinese merchants were carrying out an arbitrage by borrowing against the commodity in dollars at low offshore rates and investing onshore at a higher interest rate. The merchant later pays back the dollar loan.


Chinese authorities have allowed this to happen as a way of boosting credit-driven economic growth. But they have become more worried in recent months that some metals merchants have been pledging the same commodities to multiple banks, causing systemic risk in the financial system.

That's great. The problem is that as we showed recently, in a country in which $1 trillion in debt is added per quarter to a total debt load which is 150% of US (not China) GDP...

... China needs every possible source of credit funding. And as the funding deal pathway - which is a major part of China's shadow credit creation pipeline - unravels and is magnified, the economic shock will be severe.

Finally, since commodity funding deals, the transactions at the basis of the broken Chinese repo/rehypothecation pathway will become a prominent feature of the mainstream media circuit as soon as journos figure out what they are, here is a reminder of the key basics involved , as we posted over a year ago.

An example of a typical, simplified, CCFD

In this section we present an example of how a typical Chinese Copper Financing Deal (CCFD) works, and then discuss how the various parties involved are affected if the deals are forced to unwind. Exhibit 3 is a ‘simplified’ example of a CCFD, including specific reference to how the process places upward pressure on the RMB/USD. We believe this is the predominant structure of CCFDs, with other forms of Chinese copper financing deals much less profitable and likely only a small proportion of total deal volumes.

A typical CCFD involves 4 parties and 4 steps:

  • Party A – Typically an offshore trading house
  • Party B – Typically an onshore trading house, consumers
  • Party C – Typically offshore subsidiary of B
  • Party D – Onshore or offshore banks registered onshore serving B as a client

Step 1) offshore trader A sells warrant of bonded copper (copper in China’s bonded warehouse that is exempted from VAT payment before customs declaration) or inbound copper (i.e. copper on ship in transit to bonded) to onshore party B at price X (i.e. B imports copper from A), and A is paid USD LC, issued by onshore bank D. The LC issuance is a key step that SAFE’s new policies target.

Step 2) onshore entity B sells and re-exports the copper by sending the warrant documentation (not the physical copper which stays in bonded warehouse ‘offshore’) to the offshore subsidiary C (N.B. B owns C), and C pays B USD or CNH cash (CNH = offshore CNY). Using the cash from C, B gets bank D to convert the USD or CNH into onshore CNY, and trader B can then use CNY as it sees fit. 

The conversion of the USD or CNH into onshore CNY is another key step that SAFE’s new policies target. This conversion was previously allowed by SAFE because it was expected that the re-export process was a trade-related activity through China’s current account. Now that it has become apparent that CCFDs and other similar deals do not involve actual shipments of physical material, SAFE appears to be moving to halt them. 

Step 3) Offshore subsidiary C sells the warrant back to A (again, no move in physical copper which stays in bonded warehouse ‘offshore’), and A pays C USD or CNH cash with a price of X minus $10-20/t, i.e. a discount to the price sold by A to B in Step 1. 

Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration. 

Copper ownership and hedging: Through the whole process each tonne of copper involved in CCFDs is hedged by selling futures on LME futures curve (deals typically involve a long physical position and short futures position over the life of the CCFDs, unless the owner of the copper wants to speculate on the price).

Though typically owned and hedged by Party A, the hedger can be Party A, B, C and D, depending on the ownership of the copper warrant.

* * *

Please note the bolded, underlined text above. That's more or less the whole story here.

* * *

How an unwind may impact each CCFD participant

As we discussed on pages 4 and 5, SAFE’s new regulations target both banks’ LC issuance (first measure) and ‘trade firms’ trade activities (second measure). Here we discuss how the different entities (A, B, C, D) would likely adjust their portfolios to meet the new regulations (i.e. what happens in a complete unwind scenario).

Party A: Party A, without the prospect of $10-20/t profit per Step 1-3 iteration, is likely to find it hard to justify having bonded copper sitting on its balance sheet (the current LME contango is not sufficient to offset the rent and interest costs). As a result, Party A’s physical bonded copper would likely become ‘available’, and Party A would likely unwind its LME short futures hedge.

Party B, C: To avoid being categorized as a B-list firm by SAFE, Party B and C may reduce their USD LC liabilities by: 1) selling liquid assets to fund the USD LC liabilities, and/or 2) borrowing USD offshore and rolling LC liabilities to offshore USD liabilities. The broad impact of this is to reduce outstanding LCs, and CCFDs will likely be affected by this. It is not yet clear what happens to the B-list firms in detail once they are categorized as such. However, if B-list firms were prohibited from rolling their LC liabilities this would increase the pace of the CCFDs unwind. In this scenario, these trade firms would have to sell their liquid assets (copper included) to fund their LC liabilities accumulated through previous CCFDs.

Party D: To meet SAFE’s regulations, Party D will likely adjust their portfolios by reducing LC issuance and/or increasing FX (mainly USD) net long positions, which would directly reduce the total scale of CCFDs and/or raise the LC financing cost, respectively.

* * *

Finally, how much leverage, and risk in general, is involved with the unwinding of CFDs?

Leverage in CCFDs

Below is a demonstration of the LC issuance process in a typical CCFD. Assuming an LC with a duration of 6 months, and 10 circuit completions (of Step 1-3) during that time (i.e. one CCFD takes 18 days to complete), Party D is able to issue 10 times the copper value equivalent in the form of LCs during the first 6 month LC (as shown from period t1 to t10 in Exhibit 10). In the proceeding 6 months (and beyond), the total notional value of the LCs remains the same, everything else equal, since each new LC issued is offset by the expiration of an old one (as shown from period t11 to t20).

In this example, total notional amount of LC during the life of the LC = LC duration / days of one CCFD completion* copper value = 10. In this example, the total notional amount of LC issued by Party D, total FX inflow through Party D from party A, and total CNY assets accumulated by party B (and C) are all 10 times the copper value (per tonne).

To raise the total notional value of LCs, participants could:

  • Extend the LC duration (for example, if LC duration in our model is 12 months, the notional LC could be 20 times copper value)
  • Raise the no. of circuits by reducing the amount of time it takes to clear the paperwork
  • Lock in more copper

Risk exposures of parties to CCFDs

Theoretically, Party B risk exposure > Party D risk exposure > Party A risk exposure

  • Party B’s risks are duration mismatch (LC against CNY assets) and credit default of their CNY assets;
  • Party D’s risks are the possibility that party B has severe financial difficulties. (they manage this risk by controlling the total CNY and FX credit quota to individual party B based on party B’s historical revenue, hard assets, margin and government guarantee) (Party D has the right to claim against party B (onshore entity), because party B owes party D short term FX debt (LC)). If party B were to have financial difficulties, party D can liquidate Party B’s assets.
  • Party A’s risk is mainly that party D (China’s banks) have severe financial difficulties (Party A has the right to claim against party D (onshore banks), because Party A (or Party A’s offshore banks) holds an LC issued by party D). In the case of financial difficulties for Party B, and even in case Party D has difficulties, Party A can still get theoretically get paid by party D (assuming Party D can borrow money from China’s PBoC).

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Cognitive Dissonance's picture

The straw that breaks the Chinese camel's back?

Headbanger's picture

Or is this the Black Swan that breaks the entire global financial system?

Cognitive Dissonance's picture

So much for 'bonded' warehouses. I bet you the banks that issued the bonds also issued the sixty loans on each pile of copper.

Badabing's picture

It’s so easy to point the finger, but us ZHrs know that it’s not just China.

It doesn’t matter what commodity or what warehouse the paper game is too easy to cheat at.

Fractional reserve banking has been around for a long time, and basically this is a note for goods.

Nothing new under the sun, this world wide rehypothedecated fiasco will come crashing down, human greed will assure that!  

COSMOS's picture

Bullish for copper and other metals.  Peru should do well right Dochen?

Australia also.  Hey how does Australia rate with you guys as far as a SHTF country to go to scenario?

Cognitive Dissonance's picture

I hear the Outback is pretty this time of year. Might want to bring a few extra bottles of water though.

COSMOS's picture

Yeah I know its dry but drought has been a problem in quite a few places.  And down south along the coast they do quite well with rain.  Also Tasmania is nice and wet.  But I was thinking of the beaches mostly along the gold coast.  Would be a nice place to sit on the beach and watch the rest of the world melt down.  Also English is spoken there so fitting in would be easy. NZ is not too far if one wanted some good skiing.

Dochen I pick Australia for my choice of country to go to.  Now I just have to figure out how to get them to let me move down there.

Also I was thinking most of the nuclear blasts will happen in the Northern hemisphere and the jet stream will pretty much ensure total coverage of that half of the Earth.  I figure less stuff will get bombed in the Southern Hemisphere.

Government needs you to pay taxes's picture

Better have a fast-firing rifle for your day at the beach.  Rumor has it the PRC likes to accumulate precious metals, and they are itching to use their shiny new blue water navy!

y3maxx's picture

""The Western lenders involved include Citigroup Inc., Standard Chartered PLC, Standard Bank PLC, ABN Amro Bank NV, BNP Paribas SA and Natixis""

....But where is Goldman(USSA Government) Sachs?


Goldman(USSA Government) Sachs set this all up.

Cognitive Dissonance's picture

Kind of convenient they previously sold their commodities units.

Must just be a coincidence.

disabledvet's picture

Goldman didn't. They're up to their eyeballs in long copper.

Elon Musk could bring one chunk from outer space and the entire market would collapse.

That includes the refining space.

It's probably already even done/down actually.

Goes a long way towards explaining why trying to trade long gold, silver, palladium, etc has been a total widow maker even as the equity space "moon shots."

Four chan's picture

maybe the term "being shanghaied" will come back into the vogue.

Cognitive Dissonance's picture

GS sold their commodities trading and warehousing units. I didn't say they sold their commodities.

CrazyCooter's picture

After all, collateral is soooo last century.




CheapBastard's picture

"Last bamboo shoot break Panda back."


~ Old Chineee proverb

Fish Gone Bad's picture

Anyone remember the melamine poisonings?  This is was really foreseeable now wasn't it.

dontgoforit's picture

Every country's got their own Wise Guys.

Bro of the Sorrowful Figure's picture

id take my chances with australia over the US. sparsely populated and if the statists ever come for you at least you can laugh at their silly accent.

CrazyCooter's picture

I picked Alaska, but hey, that is just me.



DoChenRollingBearing's picture

I`d bet the weather is getting rather nice up there now, C.C.  Enjoy your summer!  

Regards back at you!

DoChenRollingBearing's picture

Statists appear to be as much of a problem (or more) in Australia as in the USA.  I`d pick the USA over Oz, but that`s just me.  We have found, much to our regret, that statists in Peru (tax authorities) can be as picky here as anywhere else.  Must be their job or something...

S Hemisphere does offer more protection if Fukushima goes wild, but since it has not in two years, well, it probably won`t.  If it does, we will react quckly and G.O.O.D. really fast, even if it means first class...

Peru will suffer if China buys less copper, Peru *may* have entered a slowdown, after almost 10 straight years of impressive growth.  But, if much of the copper in China is indeed GONE, and China DOES keep its growth going (somehow), then Peru will benefit as then they will have to buy actual...copper!

But, trees do not grow to the sky.

Vampyroteuthis infernalis's picture

It’s so easy to point the finger, but us ZHrs know that it’s not just China.

This statement is true. It is just China is more efficient in most manufacturing including Ponziomics!

teslaberry's picture

a financial crisis in china results in massive flood back to u.s. treasuries and could be the event that helps mop up the 3 trillion balance sheet at the fed ( allowing interest rates to rise slowly while not breaking the back of the treasury )

ozman's picture

Finally someone saw this and connect the dots. All ponzis continue until someone stops the music. Japan back in the 80s marches on until the Plaza accord called in by the US which led to the changing of the Basel rules that hurt Japan, they have not been back as Japan unlike China is a saptrap unable to stand up to the US.  They could have liquidated their Treasury holdings and stop the game but they didnt instead continued the printing game resulting to lost decades.

China on the other hand march with a different drum.  They knew what is going on, they knew the people who did this scam have already fled to the US, Canada, Australia, New Zealand and Europe, the purpose for this is to create a crisis that could be an excuse to recapitalize their banking system by unloading treasuries, muni bonds, MBS and other paper assets from the western nations.  These paper assets will flood back to these countries.  However in contrast to your theory, the fed and ecb are stuck in zirp/nirp.  The fed and ECB will purchase all these assets through moar printing in order keep rates low or else the derivatives such as IRS and FRA will pop causing more problems.  If you add the de-dollarization process, these new printed cash will not find much places to go as most nations will not want them and when China starts unloading, the stampede to the exit will get bigger, moar printing will be required.  The rejection of these assets first from China through liquidation of these collateralized contracts and write off/recapitalization of banking assets will lead to also dumping of the dollar with other nations also following suit.  The years of exported inflation will finally catch up to these western nations in at least 2 years time when the unwind began by that point it will be very, very difficult to stop labelling the phenomenon occuring in the US, Canada, Australia, New Zealand and Europe as hyperinflation.  At this point the banking system will be forced to choose the hard pill let rates rise and sour the derivatives resulting to the dreaded bail in or let hyperinflation continue until the people bring in the guillotine (of course they have to beat the police/dhs first or convince these folks to join them when these enforces find the paychecks paid by the state is not worth a thing).  

As for China catching these wise guys who have most likely fled, they don't need to punish them, the result will punish them indirectly.  The crisis will result into problems in western banks causing bail-ins of these people's assets.  The rise of populism in these western nation societies ensures that these people will end up internment camps, assets seized and maybe even lynched in race riots that will ensue.  At that point, China's government will not provide asylum to these folks as they all know they have bounty (firing squads awaiting) on their heads going home.  It is a lose-lose situation for these scamers, the wise guys aint so wise after all.  


PT's picture

Never mind that!  It can wait till tomorrow!  There's important news out there!  Rik Mayall has died!  Oh, the tragedy!  Rik is ded.  First Chrissie Amphlett, then Doc Neeson, now Rik Mayall, my world is crashing down around me.

Good thing I can't make it to the funeral.  No way would I be able to keep a straight face.  Sincere condolences to his friends and family, but I'm so glad I can't make it to the funeral.  I'd spend the whole time thinking of things like this:

Again, condolences to friends and family, RIP and farewell Rik.

... and for those of you who never knew The Young Ones, today is the day you should find out.

We will now observe a respectful one minute of mayhem.



Back to your regular program ...

TheFourthStooge-ing's picture

...A Fistful of Travellers Cheques

PT's picture

and Five Go Mad At Dorset.

PT's picture

... " and all the children will be crying, and the adults will ask, 'Why are all the children crying?', and someone will say ..."

PT's picture

And now it is the day after tomorrow and the earth is still turning and China's Evaporated Collateral Scandal is still at the second port.  See!  I told you the news could wait!  But Rik is still ded!   Waaaaaaaahhhhh!  Oh Rik!  Oh Rik!  If only ... you liked gardening!

You see, we sow the seed, and nature grows the seed ...

BobPaulson's picture

The weird thing is how much I keep on hoping that finally we get a big toppling of the house of cards, regardless of how painful it will be, just to end the game...but will it just be followed by another game?

Cognitive Dissonance's picture


Never let a crisis go to waste.....especially a manufactured one.

falak pema's picture

that's what those Korean mammys are now saying as they go on a sex for money spree to old men with manufactured blue pills. 

CPL's picture

One thing anyone should plan for short term or long term in any manufacturing process is disaster recovery; this is not limited to or including the following:

  1. the loss of all their architects, excom staff, directorship board
  2. loss of all facilities due to natural disaster
  3. destruction of data
  4. decontamination procedures
    1. nuclear (war or disaster)
    2. chemical (war or disaster)
    3. sewage
    4. viral/disease
  5. theft

There are so many moving parts to it that 'it' could just about break anywhere.  First you give the benefit of the doubt, if not...well other people's pride comes before the fall.  Weird how things work out like that.  My guess however is when this Humpty falls off a wall, there will be no king's ever again

DoChenRollingBearing's picture

And yet so few do.  Long-term thinking is hard to find.

HardlyZero's picture

String together all these Chinese shipping ports in a (infinite) loop, and it looks like the Escher sketch of the stairs.

Everyone has 1/10th of the assets walking around, but when you are on the bottom walking up (upside down) everything gets divided and you 'show' 10x assets.


Finance at its best (worst).

Who's on first ?

Don't even try to figure out if the ports are incoming or outgoing tangibles, from who, when, mixed pallets ?

One day this will happen to all tangibles, including precious.

Occident Mortal's picture

Quick, devalue everybodies savings to recapitalise these poor fraudsters.

disabledvet's picture

Quick...go on a production spree that causes banks to start paying ten percent interest to savers.

AR's picture

Hey CD:   Loing time no chat...  Congratulations on the success of your new site.  I hope you and the family are doing great.  I saw you posted and thought I'd drop you a note to say hello.  You take care and keep up BOTH your spirits, and great work.

Sincerely,  AR

Cognitive Dissonance's picture

Wow, a blast from the past.

Nice to see you haunting the ZH threads AR. :)

COSMOS's picture

What site are we talking about?  Lets put up a link


Cognitive Dissonance's picture

Sorry! You do not qualify.


You must be this tall to ride.------------------------------------------>








Mark Urbo's picture

There is a Black Swan around the corner...


..what will it be ???

Seasmoke's picture

I keep having a dream that's it's a bunch of bridges collapsing at once. I no longer like driving over bridges. 

dontgoforit's picture

Asteroid on Wall St., or hemoroid on Main?

exartizo's picture

...this is a Tempest In A Teapot, at best.

Governments simply Print and Bail.

The only Black Swan events of consequence are unpredicted war.

e_goldstein's picture

Or is this the Black Swan that breaks the entire global financial system?

Technically, a Black Swan is something that no one sees coming. Tyler called this over a year ago; but yeah, the potential is there to break the system, and when it happens, that will be an interesting day.

headhunt's picture

VIX nice and calm, waiting for the SLAM!