China's Rehypothecation Scandal In One Chart

Tyler Durden's picture

Remember how small Greece was and how it wasn't relevant to US stocks... until suddenly it got close to breaking up the EU and the world's markets slumped. Remember how small subprime was? Remember how Lehman was not a 'big' bank? We hear the same "why would that impact us?" chatter now about the China rehypothecation scandal and we suspect the outcome will be just as dramatic a "whocouldanode" moment for many. The problem, as this chart so simply explains, is "more warrants than the volume of the underlying physical commodities have been issued in the repo business" and that is a problem for every foreign bank that was tempted into China's carry trade (which is "every" bank).

Simply put - the collateral that I promised you on my loan... I also promised to between 10 and 30 other people... but we're good right?



The “repo” business in commodities in China is similar to any other “repo” business in the financial markets. Generally speaking, the repo is a short-term FX funding vehicle, whereby a commodity owner first sells the commodity warrants issued by bonded warehouses (paired with an equal amount of short positions) to banks, then buys the package back from the banks in 3 to 6 months. It is a way for commodity traders/refiners to gain access to foreign banks’ balance sheets and improve liquidity efficiently.

The Qingdao situation alleges the issuance and pledging of more warrants than the underlying physical commodity. Were this to have occurred, foreign banks may be exposed to asset write-offs due to potential collateral shortages and/or losses. As a result, some foreign banks may have reduced or suspended their commodities repo business in China, and could be undertaking further investigation as to whether to make any suspension permanent.


The initial reaction is likely to be to significantly reduce the exposure to different repo businesses and investigate whether there are any other multi-pledge issues in other deals. This is already happening in the market.

A further potential reaction, in our view, is for the banks to investigate the broader spectrum of their Chinese commodity financing deals (i.e. not just the repos or CCFDs, but the whole book) in order to clarify:

  • whether these deals are exposed to substantial underpriced risks;
  • whether the banks as a whole still want to continue the business;
  • if they choose to continue, what rules could be established and enforced.

Our base case is that, even if banks do not find any further cases during the investigation periods, they are likely to raise the bar for Chinese commodity financing deals in general, in order to broadly lower the exposure to this sector. This would occur via higher funding costs for the arbitrageurs, thereby slowly disincentivising repurchase deals and CCFDs, and resulting FX inflows.

*  *  *

In a world where central banks have encouraged levered carry trades everywhere, a crack in the virtuous circle - such as we are seeing in China's fractional-reserve commodity financing deal business - will rapidly lead to a sell first (unwind first), think later mentality.

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ebworthen's picture

There's that "liquidity" term again.

Good thing central banks provide liquidity (heroin) for the engines (addicts) of our economies, eh?

BaBaBouy's picture


They Can't Repatriate The GOLD... Taking 7 Years? Bullshit...

How Many Times Is GERMANS GOLD ReHypedPothicated ???

Temporalist's picture

Jeffrey Christian says that this is all perfectly normal.  And Blythe Masters is just hedging.


All above board; nothing to worry about.

Vampyroteuthis infernalis's picture

It looks like passing paper around in a giant pretend scheme. This will end well.....

jal's picture

Ya! Right on!

Who needs assets to lend new printed money.


thisisjustarandomusernameicreatedforzerohedge's picture

On Monday, PBOC provided more liquity via lower capital ratio requirements for banks.

PBOC will likely continue to either lower 'liquidity requirements' so that they can lend more while also pushing down rates so that banks can lend more cheaply.

This will certainly be in part to make sure those who use copper as collateral can, in fact, either maintain or 'secure' their collateral.


There may be a day when China has an inevitable hard landing but the PBOC has a LOT of tools left. A hard landing could lead to social revolution... and think for a second... look at the lengths that the West go to prop up their economies... and how overextended they already are. Now consider what lengths the PBOC would go to in order to secure their ecnonomy and maintain order, and how yet underextended they are.

Point is nothing about what's right or what's fundamentally logical, but what is realistic -- and it's not realistic IMO that the PBOC lets anything significant happen from this any time soon because they have too many tools left and too much to lose.


macholatte's picture


PBOC is not the FED (or the EU) and has the advantage of looking at what the Fed & the EU have done and the mess they have caused. Let us hope they learned from it and come up with something new and refreshing, like maybe allowing some banks to fail.

Has Goldman infected China yet?

Wild Theories's picture

Providing liquidity injections to the credit market isn't necessarily trying to help broken companies stay afloat, even if they do manage to do that. It's about keeping the credit market stable.

I think that might be a common misconception "they are trying to save broke companies!" umm no, they are trying to keep the macro environment calm and ticking. 


I'm not even sure about all the talks of hard landing, so far the scale and scope of everything going shit in China just don't add up to end of the world scenarios yet.

Scams always happen in China, even on a bright sunny day. It's how big the actual scale is that determines whether you should laugh or shit your pants.

thisisjustarandomusernameicreatedforzerohedge's picture

oh i agree they have no problem chopping the heads on execs or officials it's all about keeping the masses happy and their rule stable

hobopants's picture

This kinda reminds me of how the Fed won't let anyone audit the Gold vaults either.

zorba THE GREEK's picture

you mean the "tungsten" vaults?

hobopants's picture

I always imagine it as being confronted by a brick wall that is spray painted gold as soon as you open the vault door, like "see there is so much gold in there you can't even walk inside".

newworldorder's picture

An audit would be so barbaric. Why do you want to be a slave to tradition?

cooky puss's picture

Seeing no upvotes on that, I can tell you I personally got that reference to Berspankme vs Ron Paul audition.
+1 bro ;) 

Kirk2NCC1701's picture

Malaka!  This chart looks like a Circle Jerk.

p.s. I noticed only after I posted mine that Pods had posted the same comment earlier.

pods's picture

Chinese knock-off of a circle jerk.


CheapBastard's picture

Hey! Wait one second, Wang Fu. I have this paper right here, "Warranty Certificate of Ownership" that shows I own 5 tons of copper. See, it's written right here and even has the gold seal of BBbC, 'Better Business Bureau of China.' It's also signed by Ho Lee Phuk, the CEO.


thisisjustarandomusernameicreatedforzerohedge's picture

Phuk doesn't even remotely look like a Chinese name... maybe Vietnamese or the first 10% of a Thai name


if you're going to jump on the meme wagon, at least use a name that could even remotely pass as a Chinese name to anyone that isn't a rural redneck like Sum Ting Wong ... 

zorba THE GREEK's picture

I ate at a Chinese restaurant in Philadelphia called Fooks. How about Ho Lee Fook?

astoriajoe's picture

except its octopi doing the handiwork.

ToNYC's picture

Federal Reserve re-hypothecates USD by fractional division bounded only by us belief, like a cult and the worshippers of the "free" god.

The Duke of New York A No.1's picture

Bundesbank says: "7 years!... 7 freaking years!!!!!!!!"

holgerdanske's picture

Much longer, I think, if ever!!

Last figures I seem to remember is 5 tons out of the US and 32 tons out of France or about 37 tons total.

And that in a period of more than a year!

I think the total outstanding is about 670 tons. So I guess, at this rate, about 20 years.

I think the trend is clear. Fuck the shut up, and be glad if you get any!


And that after Merkel and all her staff have been spied on by the US.

How to win friends and influence people!@!LOL

We are so fucking screwed!

shovelhead's picture

Cuz we gots dragons protecting the gold and we have to wait for them to fall asleep to get it.

Thats why.

Jonas Parker's picture

Sounds like a Chinese version of "The Cargo Cult" on steroids...

LawsofPhysics's picture

< shocker >

At least the chinese will execute some of these useless paper-pushing fucks.

Americans will promote the criminals, maybe even make them president.

Jam Akin's picture

A microcosm of the reported $1.6 Quadrillion in derivatives floating around the world nowadays...

dontgoforit's picture

Bait & switch; borrow against inflated stock or anachronistic inventory.  I've seen it done.  Cost more than just the bank losses.  This is very bad business.

i_call_you_my_base's picture

Why now? Were people defaulting and getting called? Or was this timed?

Angry Plant's picture

Commodity values dropped because of the over production caused by drop in Chinese demand.

People that made the loans suddenly wanted out because they didn't want to hold copper as collateral when price was dropping.

It should have been a simple sale of the copper and use  money from that to repay the loan. But you cant do that if you have used the same copper as collateral multiple times,



JuliaS's picture

The empty silo example is commonly used to illustrate the fraud behind fractional reserve lending and leverage. China does it quite literally... and uses fiat for that extra kick.

There's been a few articles on ZH recently about departure from USD in the Eurasia in favor of Yuan. I see no reason for excitement whatsoever. Dumping a questionable brand of toilet paper for a worse one... that has already been used. How's that a solution?

Jam Akin's picture

Let's see if the news prompts local holders of "Brand Y" TP to accelerate their switch into precious metals.  

As an aside, was in China recently - still many construction cranes about but the "job sites" were not exactly - shall we say - a beehive of activity. 

oddjob's picture

When does shit on copper week end?

astoriajoe's picture

how many ports in China have commodity storage facilities?

MarkEm's picture

Would someone be kind enough to explain the events that occur in the graph between the different parties?

Hindenburg...Oh Man's picture

wake me up when gold gets above 1400/oz again.....and is on its way up

Atlas Crapped's picture

Sorry to say, but China, and copper are not the only country / banks / commodity to have UNLIMITED PAPER SUPPLY collateralizing their so called "liquidity fundamentals". This is how the real world functions lads. EVERYTHING IS REHYPOTHECATED by the paper that backs it, and the supply of paper is endless.

The much larger issue is how and when IT ALL unwinds. Copper is but a pimple on the ass of global rehypothecation. If it unleashes the Kraken of reality, so be it ....

matrixman68's picture

I give this till the end of next week to blow up.

Angry Plant's picture

Not so sure most of the paper copper is used by banks for collateral they really don't care if central bank steps in and hands them fiat instead, Foreign banks may get stuck with RMB instead of copper but that's not a huge problem right now, but could become a issue in the future. Short term the problem is Chinese companies will no longer be able to use this scam to build up debt and acquire FX. The result will be a sharp reduction in Chinese growth rate with a very high chance of it going negative when this is combined with other problems. Longer term the massive money printing of RMB(its really China's only option at this point) will cause inflation China and make RMB worthless overseas.

But that's the price you pay when you trust shady foreigners and try and bypass using the US dollar in trades and financial deals in order to prevent fraud.

Quinvarius's picture

Keep telling everyone to sell because the warehouses are empty.  See how that works out for you.  The Chinese will fill those warehouses or be executed.  Copper is going to double. Tell the noobs at GS to leave China if they want to live.  Their panicy charts and mumbo jumbo is laughable.  Just a month ago they were telling everyone to sell becasue the warehouses were full.  Now they are apparently empty and they are telling everyone to sell for that reason. 

jubber's picture

Hong Kong futures at HOD...?

falak pema's picture

whats the big deal?

500 000 tonnes of copper is worth 3.3 billion $.

No big deal. If that sort of collateral disappears from China's vaults.

shovelhead's picture

A little paper and ink and everyone except the guy who needs the copper is happy.