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China's "Evaporated" Collateral Scandal Spreads To Second Port
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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Yuanswined
Gold, Silver, Copper... uuuummmm ... me thinks... this is a bank run.
What have we been doing since 2008 piggies?
We’ve been stacking and packing – right! And so has all the smart money...
First we get the run... then we get the Crash... then we all get screwed and shiny new fascist bosses.
Then the BIS get the BIZ... => the World Currency Unit... that shitty “SDR” basket case to replace Yellen’s shit house paper.
Then they start the new Ponzi with the central bank of central banks.
And we all get to bid on gas with the same reserve currency – again, sadly.
I could fucking cry...
But is it....better...than....EXPECTED!!!
"A private Company in China".The banks can't get their hands on the assets that they think are theirs' because the scam has been going on for a very long time.So,where are the Chinese Government linked people behind the so-called "private Company?" Well,they're long gone.That's why Canada finally shut down their immigration program that allowed the rich to come into Canada just because you got lots of bread.In turn though in order to get in,you had to buy up Canadian debt for so many years.You could pledge the money to Ottawa because they are short of tax revenue.That's where we get back to Prime Minister Stephen Harpers' war in Afgan-Land in support of the Pentagon.Pass a law in Canada to stop any public knowledge of how much the war costs (billions) and at the same time in the name of National Security you have nothing to worry about.He wants to balance the budget before leaving office and has billions now from illegal money from China.At the same time the country has been flooded with X-Commies that could see the Governmennt corruption and could get a free ticket to Canada. No different than corrupt Chinese Officials leaving and buying up real estate in the United States.To shoow you how stupid it worked in Canada,a corrupt Chinese Official could actually get in through getting McDonald's to sponser him on a job training program and he could come to Canada.Or,just get in the old money in your pocket route.Get your money out!!!
China is funny
"Rehypothication is not against the law." -- Jon Corzine
The only good sad thing is the word 'rehypothocation' is common now, and Corzine put it on the above board map.
Will Bronze Swan transmute ?
where IS the GERMAN gold.... ahhh we'll deliver it to you in 5 years... how do you say that, substituting "copper" for "gold" and translated into mandarin.... and i mean gold without the tungstun core...
amateur unsophisticated fraud.... basic street criminality....
while on the other hand we have the FED... sticking it up the taxpayer ass and awarding themselves bonuses.... serving with honor and distinction... the pillars of our "society"..... bespoke suited polished sophisticated fraud
take your choice... who has the bigger problem
Henry Ford was right and the armament of local pd's and ammo hoarding and arming of govt agencies is the weathervane of when his statement of what the people will do when they find out .... so again whohas the bigger problem...
This scandal will prove again the Greatness Of Unlimited CB Printing.
So why when Hypothecation is discovered does the underlying tank?
in just 15 seconds, this sums up the global "financial services industry" perfectly.
https://www.youtube.com/watch?v=-DT7bX-B1Mg&feature=kp
"Please step aside"
Love it!
That is a lot of horseshit charts and horseshit math trying to explain why prices will drop when warehouses are empty.
Yes.
However the point is...Pure Fiat + Fianance + Fraud = today's tangible markets.
If the Finance (1 of the 3 F's) gets destroyed then the faux flimsy house of cards collapses.
The Finance is the banks. As banks collapse the local tangible markets will get wiped out and many businesses.
This will eventually lead to great Zimbabwe style depression and recession...as tangible markets collapse.
There will be .... no milkshake.
There's a hole in Daddy's arm where all the money goes.
I said just yestereday right here on ZH that naked collateralized repo fraud was going to be discovered at ALL the Chinese ports.
Just wait until the rehypothecaton pyramiding and phantom collateral problems surface at ports in the United States.
IF the Feds aren't on the docks right now it's only because they are terrified to actually verify.
If they pull the floating sheets off the cartoony ghosts and find that there was really nothing but Linda Green's photo-shopped invoices defying gravity and dancing them around in the haunted empy warehouses -WHO is ultimately culpable??
Just wait until someone realizes that many of the offshore oil tankers are empty and significant refinery caches are mirages, too. This isn't your uncle's PhiBro...
You ain't seen nothing yet. IF this is a crisis it is a undoubtedly a manufactured crisis.
Anyone want to take the over/under on whether or not the US Gov't would admit that the dock warehouses were/are running a giant pyramided fraud for years or whether TPTB would 'lose' the collateral in a false flag event(s) and the Feds pay the insurance to cover their tracks and keep everyone in on the scam out of prison?
A destroyed port/refinery/storage site would make dragging the Nation into WAR much easier.
-It would make a big FED print/un-taper much easier.
-Maybe Keystone and the like would suddenly be fast-tracked, too.
With the World cup now imminent one has to ask oneself to what extent is Sepp Blatter's ass rehypothecated in his dealings for 2018/2022 world cups?
He or his team of puppet masters run by the usual suspects of Oligarchy sponsors (Nikespikesbest, Coca Killa, Adildoass, VisatoZimbabwe etc.) are in for a grilling.
When Fellujah falls and Mossul follows you know that surrogate Iraq is looking like that beam that fell on the worker in Sao Paulo. Frankenstein type horror blues hits Iraq's Maliki regime bigtime. After Syriadestruction its back to Tigris obliteration.
Not good for shia sunni rabid confrontation in the making in Kurdistan oil regions and around.
What the neo cons have achieved will be an all-mighty rebirth of Sunni rabid Islam that will make Sultan Baibars revival the Leitmotiv of the coming decade. Having spawned that back in 1978 in Iran we are now getting a remake in Sunni Arabia. Not good for the sanctuarised Monarchies. Salafist Sauds now looking out Salafized by the ISIS types.
What you sow you then reap. Oh when the CIA could think and chew gum all at the same time.
Enron accounting lives! The clan of dishonest accountants is currently accepting recruits but only if you pass the test. Yeah, you know the test.
And what, pray tell, does Goldman have to say about the ETF GLD?
There is so much more to this. It is not just metals but so many other commodities. It is going to be brutal and China's government cannot control this,because is way too big. This is China's subprime moment.
I go a really different place with this. Everyone is doing it in all the commodities. Everything is naked short rehypothecated straight up the wazoo and out the mouth. Everybody knows and generally winks and cooperates with one another to keep the Ponzi scam going. Currency swaps, all of it.
Russia and China look to be headed for the door, they think the music is stoping and they want to get theirs and get out.
As a result, the US and her band of thugs are now at war with China and Russia. How do you fuck them up? One front would be financial. Set this shit up to be "discovered" let it ferment, brew, whatever, and watch it blow up on them. Our "big boys" (Sachs, Morgan, etc.) get a heads up to sell their commodities trading stuff to get them out of it.We suffer collateral damage too, but not as bad as them. We act innocent and blame them for all of this. I bet the US public would swallow just fine.
Eh, it's a theroy.
Here is Chris Martensen to explain the causes and consequences of rampant re-hypothecation.
https://www.youtube.com/watch?v=9jaQmcYEiME
The nice thing about globalization is everybody gets to go to hell in the same bucket...
https://www.youtube.com/watch?v=01AC4Y2E0t8
Tyler - (and anyone with an opinion) a question.
The fraud is now exposed - and it's bigger than was thought (In the MSM) a week ago.
There is less copper 'out there' than has been reported. The warehouse said 500k tons - there is only 200k tons because of the fraud.
What the market 'thought' was a global physical supply of X, is actually going to be X minus the made up amount.
With each announcement (there will be many more) the perceived global physical supply will be reduced.
So why is this bearish for copper??
Note: Thankfully, I have no position in copper - but if I understood why it was a short (or a long?) I would roll the dice, so any help would be appreciated.
bk
what's the price of Cu expressed in USD/ton?
You do not want to hear from me but I can't resist. Maybe someone will tell me why I am wrong and that will start the conversation you want to have.
It is the fact that everyone will want to exit, all at the same time, because of the perception of "no copper behind the paper contracts" that in the short term should kill the price. The way I see it, all the paper copper will flood the market, and no one will want to buy it. People will be desperate to get something, anything, for it.
I think it will take a long time to sort out the legalities too. No one will want to be involved in it if they can get out of it with something.
Meanwhile, someone is going to eventually need some real copper to actually do something with it. But maybe not that soon. The real activity of building is down. But if you want real copper and don't know who is lying to you about actually having it, you may want to do something else, even if it is your livelihood!
I'd stay out of it (the trade), but I stay out of almost everything.
I share MsCreant's line of reasoning.
The former demand was the mirage and thus the price inflated.
'Demand' for the commodiites in question was not only pulled forward via the repo and credit pyramiding; but, that demand was erroneously 'priced in' during the repo procession and credit pyramiding phase.
NOW that faux demand is going to come OUT in a much shorter period of time than it was built up causing an over-adjustment relative to the former faux demand profile/pricing profile. Prices should under-shoot the actual existing market demand.
IMHO this episode will likely follow a classic pyramid scheme collapse.
So, what is your opinion, Mr. Krastings?
Theorization of forward/hedge activity : Miners who were wise to the faux demand pyramiding will be evidenced by a concentrated proliferation of highly over-priced forward contracts that protect them from the over-adjustment phase. Those that have already sold forward product at the bubble highs price point will probably have opportunities to consolide competitors that were not selling forward and relied on the over-priced spot market as those miners will be trying to sell into the re-pricing panic/under-shoot and experience severe cash-flow/profit pressures.
Time to know which miners specifically sold forward into the mania/repo pyramiding phase and payed down debts, and which primarily relied on the mania/repo pyramiding phase spot and took on debt into the peak...
I'm with MsCreant as well. Also, for people who need copper for real, I don't think any of them is short of it for the time being(well, the ones in China anyway), if they were they wouldn't have created imaginary copper to keep the loans rolling. If you could use the real copper you wouldn't need to to make up fake copper out of thin air, you'd actually have real copper sitting in your warehouse so you can use it one day.
edit: I see that's exactly what ThroxxofVron just said below too, my bad, ignore me.
One bearish scenario I can think of is if mid-sized companies used their copper stock to help cash flow. Now their letter of credit is worthless (maybe), stock is gone (can't produce) and they go bankrupt... so less demand for copper.
But even this would be short term and given the probable civil unrest due to layoffs I'd bet the Party would step in to help somehow.
IMHO it would likely be more profitable to short weak and over-indebted miners instead of the commodities directly.
Short those who have been relying on spot and not selling forward future production.
Short those who have piled up new debt to fund capacity expansion and/or have debt to pay off or roll over in the next 6 months.
I am merely guessing: most of the commodiites being wrehoused instead of being used was in fact over-capacity. Held in storage it was not merely collateral -it was glut being with-held from the market to push prices up. NOW both the over capacity AND the pyramiding of debt shall be revealed and cleared by the market.
IF this is going to develpe as per a classic maina bust then the glut of copper that was being warehoused and used as collateral for financial leverage/carry trading and not processed into products will be liquidated in a rush as institutions try to seize and unwind before prices destroy whatever income margin was previously generated when loans were originated.
Over capacity of commodities and commodity production itself is going to eventually be wrung out of the system via liquidation and consolidation.
With all central banks now on board doubting none of them have physical gold, or very little and not what they claim, why shouldn't they all just keep playing the "pretend game"? Who are we to threaten they can't?
Do you want to see real "Evaporation"?
The Chinese Housing market...heck, the entire world's housing scam, is about to hit full boil! Again!!
I got build myself a virtual bonded warehouse, then rent it at a discount.
well I guess "copper cratering" on account of all the missing copper aint gonna happen, instead we get inflation, inflation is what you get when reality doesn't keep up with the bank's printing, even "secured by collatreral" printing.
Blame Deutsche Bank!
China will never have a Lehman event. You forget that China is a dictatorship, with iron fisted control over the media that the oligarchsin the west only dream about, at least as of today. in China, when the old crooks who run the government give the order that no one shalt report on a topic, then, well, that is what happens. The story disappears from TV, radio, all forms of internet communications, texting, etc. They will drag a few off kicking and screaming to the gallows, and whoever was lucky enough to run away to Canada with the billions gets away scott free.