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Meet Decheng Mining: The Chinese Firm Which Rehypothecated Its Metal (At Least) Three Times

Tyler Durden's picture




 

We have written extensively about the problem surrounding the rehypothecation of "non-existent" Chinese commodities, the bulk of which have been used in some form of Commodity Funding Deal over the last few years: something which various banks have said would be the tipping point that finally launches China's long delayed Minsky Moment. After all, if there is one thing China has taught the west, it is how to kick everything that is broken about one's financial system as far as the eye can see, and then also eliminating any living witnesses just in case. And further, since virtually the entire Chinese financial sector is partially state-owned, it is rather easy for the politburo to reallocate funds from Point A to Point B in order to preserve that all important commodity - confidence.

But for all the theoretical explanations about China's profound commodity rehypothecation problems, the one thing that was missing was an empirical case study framing just how substantial the problem is. After all, it is one thing to say banks expect "X millions in losses", but totally different to see the rehypothecation dominoes falling in practice.

Today, courtesy of Bloomberg we got just such an example.

Meet Decheng Mining.

Decheng is a well-known name to those who follow developments in China's murky shadow banking system. It is the company which was sued by China's Shanxi Coal International Energy Group a week ago over missed payments. As Reuters reported at the time, "Shanxi Coal said in a statement to the Shanghai Stock Exchange it was suing six clients over a total of more than $177 million in missed payments. Of that total, $120.4 million of overdue payments were in dollars, plus a further 352.5 million yuan ($56.77 million)."

Sadly, that was as far as Shanxi Coal went - it did not specify how much it was owed by Decheng Mining and its parent company, Dezheng Resources. Arguably because the last thing Shanxi wanted was to spook some of its own vendors and creditors, especially as Chinese coal prices fell to record lows over the past week exacerbating the plight of the local coal industry.

Yet one reason why Decheng's sudden insolvency did not come as a surprise is that it was one of the main companies investigated by Chinese authorities over precisely the rehypothecation scandal that was engulfed China's third largest port, Qingdao, having been accused of obtaining multiple loans secured against a single cargo of metal.

As of today we know exactly why Decheng was unable to pay its bills.

As Bloomberg reports, Decheng Mining pledged the same metals stockpile three times over to obtain more than 2.7 billion yuan ($435 million) of loans in China’s Qingdao port, a person briefed on the matter said, citing preliminary findings of an official investigation.

From Bloomberg:

Local authorities are checking metal inventories worth about 1.54 billion yuan including 194,000 tons of alumina, 62,000 tons of aluminum and some copper, the person said, asking not to be identified as he isn’t authorized to speak publicly. Two calls to Decheng Mining, a metals trading house based in Qingdao, went unanswered.

 

Foreign and local banks are examining lending linked to metals at Qingdao amid concern that risks are more widespread in China, where traders use commodities from iron ore to rubber to get funding. Steps by the Chinese government to rein in credit raised companies’ borrowing costs in recent years and triggered a surge in commodities financing deals that Goldman Sachs Group Inc. estimates to be worth as much as $160 billion.

 

“The whole Qingdao probe will just keep fermenting, inevitably leading to banks increasing their scrutiny of commodities-backed financing activities,” Fu Peng, chief strategist at Galaxy Futures Co., said by phone from Beijing.

 

Bank of China Ltd., Export-Import Bank of China, China Minsheng Banking Corp. and 15 other Chinese banks have lent a total of about 14.8 billion yuan to Chen Jihong, Decheng Mining’s owner, and his companies, the person said.

Well that is a little over $2 billion that the lenders will never recover as the money has almost certainly been (re-re-) used to purchase commodities which were then repledged countless times in order to generate the arb we first described in May of 2013.

Chen, a Singaporean national, has been detained and the city-state’s foreign ministry is providing consular assistance to him and his family, the ministry said June 11. He is also involved in a separate inquiry in northwestern Gansu province, two bankers assisting with the probe told Bloomberg last month.

 

The collateral ratio for loans to Dezheng Group, Decheng Mining’s parent, was 55 percent as of June 13, Minsheng Bank said in a text message in response to questions last month. That means for every 100 yuan of collateral offered by the borrowers, 55 yuan was given in loans.

Unfortunately for Minsheng, that number is a clear fabrication considering the real collateral to loan ratio is more like 300%.

Press officers at Bank of China and Minsheng Bank based in Beijing declined to comment, while spokesmen for Export-Import Bank weren’t immediately available.

 

Local government officials are updating creditors about the probe on a weekly basis, with the latest meeting held on July 1, the person said.

 

Lenders are tightening their commodity financing criteria in the wake of the probe. Some Chinese banks have raised margins for letters of credit for iron-ore financing to 30-to-50 percent from 15-to-30 percent previously, people familiar with the matter said June 10. Others reduced overall credit available for iron-ore financing and have set up a cap on credit used in some locations, the people said.

As for the punchline, we hardly doubt we need to note it: if one trader effectively managed to "evaporate" half a billion in collateral and three times as many derivative loans, what does that mean for the entire Chinese rehypothecation industry? And keep in mind this is China - what is presented for public consumption is without doubt far better than what has really happened.

Recall from our CFD flowchart explanation a year ago, that the practical rehypothecation limit is, well, non-existent.

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.

Get that? A rehypothecation limit upward of 15x and as much as 30x. Now imaging the millions of tons of copper, aluminum and various other funding metals just sitting there, and collateralizing some 30 times their notional value in loans.

Surely this explains why foreign banks operating in China are starting to sweat profusely, especially since not only Qingdao, but a second port, Penglai, has now been implicated. From the WSJ:

Local authorities in Qingdao, and Penglai, another port city also in Shandong province, have been investigating whether the metals have been reused several times as collateral by traders and companies seeking funding. Already, a major state-owned enterprise, Citic Resources Holdings Ltd. , said some metals that it has stored at the Qingdao port can't be located.

 

But because banks can't get access to the storage facilities at Dagang in Qingdao and Penglai port where the probes are under way, the scale of any possible losses can't be tallied up.  "I have the impression that a lot of people do not know where it stands, which makes me nervous," said one executive at a Western bank.

Bingo. Actually, it can, and one word can be used to explain the losses: "lots." Or "lots, lots" if the problem is not just contained to ports but, as we also warned over a year ago, is spread across the fabric of China's entire financial system.

There is some indication that the probes may no longer be local. In recent days, one of the banks that has been seeking to access the storage facility at Penglai has been informed that the probe now include authorities from Beijing, according to a person familiar with the matter.

 

The Hong Kong Monetary Authority, or HKMA, said it is keeping a close eye on developments amid concerns that banks in the city have become dangerously exposed to China's economy through excessive lending.

 

"The HKMA has been closely monitoring the credit exposure, including those incurred from the business of commodity finance, of the banking sector," a spokeswoman said in an emailed response to queries Friday. "Authorized institutions are expected to maintain sufficiently robust system of controls to manage the specific risks that they are facing," an HKMA spokeswoman said.

But why would the Hong Kong central bank be concerned? Doesn't it know that the addition of 800,000 part-time jobs coupled with the collapse of over half a million full time jobs was just spun as the most positive jobs report in the US since 1999 and led to the first Dow Jones close over 17,000 ever? After all, can't the HKMA just BTFATH and watch its problems disappear? After all that is precisely what the US administration beckons the local middle class to do. Because who needs a job, be it full or part time, when one has an E*trade terminal.

 

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Thu, 07/03/2014 - 14:13 | 4922219 TeamDepends
TeamDepends's picture

Confucius say:  Trust, but verify.

Thu, 07/03/2014 - 14:16 | 4922230 nink
nink's picture

Only 3x?  They should have been in the 70x range like the Good old US gold derivatives.  

Thu, 07/03/2014 - 14:17 | 4922236 ParkAveFlasher
ParkAveFlasher's picture

DeCheng Mining, subsidiary of CheChing! Happy Corp.

Thu, 07/03/2014 - 14:37 | 4922307 NotApplicable
NotApplicable's picture

Well, at least it's a miner which can actually produce some metal... ummm, if they've got money to fund it, that is...

I'm confused as to how the First Rule of Holes applies in this case.

Thu, 07/03/2014 - 14:27 | 4922271 zerozulu
zerozulu's picture

No issue with gold because other metals can rot.

Thu, 07/03/2014 - 14:49 | 4922335 theXman
theXman's picture

I'm not kidding, the Chinese characters for the name Decheng(??) literally means ethical & honest.

Thu, 07/03/2014 - 14:14 | 4922223 alexcojones
alexcojones's picture

Is DeCheng related to DCRB?

Thu, 07/03/2014 - 14:17 | 4922229 yogibear
yogibear's picture

The Federal Reserve and the COMEX has fractinally reserved the precious metals.

The number people have been saying is 70 to 1.

Thu, 07/03/2014 - 14:19 | 4922244 Major Major Major
Major Major Major's picture

Decheng is need award in economic growth.  Create much value.

Thu, 07/03/2014 - 14:19 | 4922246 pods
pods's picture

Pikers.  Need to send them up and coming fellas over to the City of London and they can learn how you can really lever bullshit.

pods

Thu, 07/03/2014 - 14:39 | 4922315 NotApplicable
NotApplicable's picture

+1!

Wait, I mean

X100!

Thu, 07/03/2014 - 14:30 | 4922277 Jack Burton
Jack Burton's picture

Max Keiser loves these sort of stories. Many people slam him for being too whacky on his show, but inbetween his comedy acts, he really nails what is going on and the fraud that permeates the worlds banks and financial markets. Fraud is a polite word for the type of accounting and dealings that would, two decades ago, have brought Federal Prosecutors to your door. Now days governments and central banks encourage these types of fraud because it boosts GDP and corporate profits and lines bankers profits and bonuses. WHile it really undermines the real economy and acts as a way to strip wealth from workers and small business. The whole market is rigged all banking is now fraud. Max Keiser can only get a show on RT because he tells things that would blow "CNN Money" out of the water. Or "Fox Business". I'de love to see Max get 10 uninterrupted minutes on Fox Business, and then listen to the booms as heads explode all across America. It would likely cause heart attacks and strokes across Middle America if Max had but ten minutes to rip the lies and covers off of Banking and Markets.

The next financial crisis will be an order of magnitude worse than 2008, and the world's central banks have already taken their money printing and bad asset buying to the limit, thet don't have the power to absord the next crisis. That leaves only the IMF and their plans to flood the world with a new form of Liquidity. That action will simply strip more wealth and transfer it to the top. Then the new age of fudalism will begin, slavery and serfdom will be legal and recognized parts of the crony capitalist market. Middle Classes will hardly exist, outside the few who can land high paying jobs in serivce of the Government and the 1%.

Thu, 07/03/2014 - 14:42 | 4922326 NotApplicable
NotApplicable's picture

I slam him for being a disingenuous scumbag.

Tom Woods owned him so bad, poor Max had no rebuttals but name-calling.

So, FUCK HIM!

Until evidenced otherwise, he is but a POS.

Thu, 07/03/2014 - 15:47 | 4922541 PeeramidIdeologies
PeeramidIdeologies's picture

I didn't catch that interview, but the ones I did catch him co hosting always gave me a laugh. He always looks to be on the verge of passing out waiting for someone to fumble though an event that he himself could turn into a circus. The guy is extremely sharp, but like most of the truthsayers from years back, they have been beaten down by the printing press media monster.

Back on topic, something that is continually impressed upon me is China's willingness to take their medicine. There's a lot to be said for that IMO.

Fri, 07/04/2014 - 09:16 | 4924397 TheReplacement
TheReplacement's picture

Medicine = Firing squads for the looters and then more centralization so the ruling class regains more power and ownership.

Good for them.

Thu, 07/03/2014 - 14:47 | 4922330 Lmo Mutton
Lmo Mutton's picture

+1 Jack.

Thu, 07/03/2014 - 15:53 | 4922561 pashley1411
pashley1411's picture

Max badly needs a comb.   and haircut too

Thu, 07/03/2014 - 19:28 | 4923213 optionguy
optionguy's picture

Here,here

Thu, 07/03/2014 - 14:48 | 4922337 JustObserving
JustObserving's picture

How many Kevin Henrys can we hire from Decheng Mining? We need them desperately here as the Ponzi grows exponentially.

Thu, 07/03/2014 - 14:51 | 4922342 CHX
CHX's picture

Which country is the next to financially blow, being the lynch pin to the global financial meltdown? China? Japan? (Argentina?) One of the PIIGS (or France)? Or even the US? Or it'll just come down ~all at once? It seems the whole world is on the brink of abyss, drowning in dwbt and derivatives, but luckily stocks and bond say it's all good... ALL.RISK.PRICED.IN ??? Riiight. What a shyte storm it'll be when things start escalating for good and in the open (I think behind the scenes they are on red alert 24/7 now). Things are heating up, and I'm not sure they can duct-tape the vocano much longer. We'll see soon enough. Place your bets, soon it's "rien ne va plus". Good luck to all.

Thu, 07/03/2014 - 15:28 | 4922477 NoWayJose
NoWayJose's picture

If you think you own gold even though you cannot touch it - you don't!

Thu, 07/03/2014 - 15:35 | 4922502 ThroxxOfVron
ThroxxOfVron's picture

"Get that? A rehypothecation limit upward of 15x and as much as 30x. Now imaging the millions of tons of copper, aluminum and various other funding metals just sitting there, and collateralizing some 30 times their notional value in loans."

 

There is NO WAY IN HELL that the Banks extending the 'collateralized' loans did NOT know what was going on.  

There is NO WAY IN HELL that the Banking Regulators and Government Ports Authorities in several Countries did NOT know what was going on.

This is pure over the top rampant CONTROL FRAUD used to implement counterfeiting and expropriation of real property and impose political leverage on a massive scale.

SHOOT & HANG ABSOLUTELY EVERYONE INVOLVED NO MATTER THIER NATIONALITY OR POSITION OR CLAIMS OF INNOCENCE.

Fri, 07/04/2014 - 09:21 | 4924402 TheReplacement
TheReplacement's picture

Now you're on to something.  It is no different that the banks and gov in the US, Europe, everywhere.  They are all in on it.

Edit:  Not implying that all governments/banks are colluding together but they are all in on the scam and trying to maximize the loot they can take for themselves.  It's like mafia families copying each other and expanding from the baseline to include drugs back in the 70s-80s.  It's just too good for a crook to pass up.

Thu, 07/03/2014 - 15:39 | 4922518 VWAndy
VWAndy's picture

Accountability.

Thu, 07/03/2014 - 15:52 | 4922552 pashley1411
pashley1411's picture

Doesn't China have an equivalent of the UCC?

Thu, 07/03/2014 - 15:56 | 4922568 orangegeek
orangegeek's picture

instead of an MBS fiasco, it appears there are multiple "MBS fiasco's" brewing

 

hey yellen, what do you think?  china's good for stability, right?

Thu, 07/03/2014 - 16:01 | 4922585 goldhedge
goldhedge's picture

"Possesion is 9/10 of the Law"

Thu, 07/03/2014 - 16:18 | 4922643 Mercuryquicksilver
Mercuryquicksilver's picture

China handles these things well. My only question is in what position are they going to pose the Decheng executives at the Bodies Exhibition?

Thu, 07/03/2014 - 17:04 | 4922781 ncdirtdigger
ncdirtdigger's picture

Excuse me if I am repeating myself, but.........this is good for the DOW........right?

Thu, 07/03/2014 - 17:06 | 4922787 RaceToTheBottom
RaceToTheBottom's picture

So basically we should not have a physical only Gold system in China then?

Thu, 07/03/2014 - 18:41 | 4923100 esum
esum's picture

And how many times have the TBTF rehypothecated your financial assets................

What's mine is mine...what's your's is mine................. 

Old banker / broker / scumbag saying..........

Thu, 07/03/2014 - 19:09 | 4923165 Fred123
Fred123's picture

Don't worry, the Chinese are different and they have it under control. At least thats what some Chinese students told me......

Thu, 07/03/2014 - 20:24 | 4923373 SILVERGEDDON
SILVERGEDDON's picture

Sum Ting Wong

Me Tal Gon

Mi Fuk Bang K

 

Thu, 07/03/2014 - 21:25 | 4923569 Laowei Gweilo
Laowei Gweilo's picture

Whatever happened to the copper crash?

Fri, 07/04/2014 - 00:57 | 4923966 Wild Theories
Wild Theories's picture

You know, I've been following this from last year up till now(was a silent reader of ZH for a long time before I registered), and I'm just not buying the LC cycling part of the story for CCFDs anymore.

 

I see cycling LCs can be great for smuggling gold under false invoices through HK, where repeatitive LC cycling coupled with import of bulk gold then re-export of supposed 'gold products' will end up landing you the gold.

But the purpose of CCFDs are completely different to the gold scheme:  the purpose of the gold import/export LC cycling was to gain gold on the cheap, the purpose of CCFDs is to gain loans and not gain more copper stashes. The people financing CCFDs aren't even likely to be the same people that was bringing in gold through HK.

It's one thing to claim 10-50kg of bogus gold products mixed in with other goods in a container, or ship a batch of gold-plated items that has less gold content than advertised, how the fuck do you claim tens or hundreds tons of fake copper shipping through port customs? industrial metals like copper are shipped on special cargo barges and you can't even find other shit to substitute for the phyiscal volume, what you gonna use? a cement laden barge with a sprinkle of copper on top? You'd need to buy off both customs and the shipping company to create a fake shipment of copper through the export/import paperwork using LCs, and if that had happened, this would be a criminal investigation into customs and shipping by now. But since it's only been a banking investigation into fradulent loans, it suggests customs didn't let any fake copper through - the fraud either happened after the copper was imported, or was never imported. 

 

A wild theory(could be wrong):

The LC cycles reads more like something that was originally created during fake invoicing through HK early last year to gain more credit, then was adapted to gold rehypothecation to move gold whilst keeping price down. The only reason it's being added to the CCFDs seem like a cut-n-paste job by Goldman to cover up banks' roles.

The role of banks in these CCFDs always read too suspiciously small in Goldman's explaination of how it works, even though common sense dictates CCFDs had to be created by banks. There's no way some borrower could approach banks with a new suggestion to give themselves more loans just like that, that's just not how banking works. It was probably a profitable business deal for the banks that allowed them to give a carry-trade tap for credit-thirsty Chinese, but came unstuck when they first realised it might create an artifical demand in shit like copper(that was what the original story posted in ZH last year from Goldman was fearing, but it didn't happen because the Chinese one-upped them by simply faking copper rather than pile up a stockpile), then it became even more unstable when PBoC devalued the renminbi and started taking an axe to all carry-trade credit feeds. The fear of aritifical demand was likely known a long time ago, and the suspicion of fake copper probably came up earlier than reported, but nothing was pulicized until the original players had exited the business and sold off their hot potato units to the next willing suckers.

Most likely explanation to me is Goldman either had a hand in their creation themselves, or have a strong interest in helping the banks(there's more than likely more than one creator) that created CCFDs. So they simply cutn-pasted the LC cycling part to the CCFD explanation to make it look like the fraud is all on the borrower and the banks are the victoms so people wouldn't pause to ask "shouldn't banks be the ones who created this shit?" which would only lead to the question "which shit bank(s) was it that came up with this brilliant CCFD business?". 

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