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Chinese Commodity Contagion Leads To First Letter Of Credit Settlement Failure

Tyler Durden's picture




 

At the heart of the China Commodity Financing Deals (CCFD) is the ability to leverage a letter of credit on the basis that there was some collateral somewhere that backed the risk of this rehypothecatable 'money'. Until now, the biggest concern has been "where's my copper, nickel, gold, etc..?" as the Qingdao ponzi scheme is unveiled; but, as Metal Bulletin reports, the contagion from the exposure of CCFDs ponzi has now hit Western banks. At least one western bank has stopped discount financing of copper into China after Industrial & Commercial Bank of China (ICBC) applied for the right not to settle a letter of credit it issued earlier this year, as a result of the Qingdao investigations. In other words the collateral chains were just snapped...

As Metal Bulletin reports,

This is a new development in the fallout from the Qingdao warehousing scandal, in which Chinese firm Decheng Mining allegedly used false warehouse receipts to gain multiple loans from banks.

 

ICBC's request for the right not to make this payment is a move that is lawful in the country in cases where there are concerns about fraud.

 

It is the latest legal move by parties that may have exposure to the Qingdao fraud to try to protect their interests, sources said.

 

But if the move was granted, it would be likely to leave its counterparties out of pocket, and would risk a renewed ratcheting-up of concerns about copper financing.

 

The western bank, which was not an ICBC counterparty in the deal to which the injunction applies, has responded by ceasing to do some forms of copper financing...

This is a major problem as when the collateral chains break, the whole house of cards falls rapidly...

*  *  *

And Citi is already actively denying any exposure...

  • *CITI SAYS NO COMMODITY-LOAN EXPOSURE TO CHINESE FIRMS IN PROBE
  • *CITI: COMMODITY LENDING CONTRACTS GUARANTEED BY PARENT FIRMS
  • *CITI: FINANCING IS WITH MULTINATIONAL FIRMS' NON-CHINESE UNITS

Good luck with that legal case...

*  *  *

But as we explained previously, LCs are crucial in the leveraging of the actual commodity deal...what does all this mean for explicit rehypothecation chain leverage (initially just at the CCFD level although a comparable analysis must be done for systemic as well) and CCFD risk exposure:

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).

In brief (pun intended): a complete, unpredictable clusterfuck accompanied by wholesale liquidations of "liquid assets", deleveraging and potentially a waterfall effect that finally bursts China's bubble, all due to a simple black swan. Although, in reality, nobody knows. Just like nobody knew what would happen when the government decided to let Lehman fail.

So... is this China's Lehman?

*  *  *

Just as Lehman hit the US when trust failed, this first failure of settlement in China's CFD shadow market is yet another straw on the camel's back...

Don't think it can happen? Think again - China money market rates are surging as liquidity demands soar...

 

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Fri, 07/18/2014 - 17:46 | 4975469 max2205
max2205's picture

MOSCOW — A top pro-Russia rebel commander in eastern Ukraine has given a bizarre version of events surrounding the Malaysian jetliner crash — suggesting many of the victims may have died days before the plane took off.

The pro-rebel website Russkaya Vesna on Friday quoted Igor Girkin as saying he was told by people at the crash site that "a significant number of the bodies weren't fresh," adding that he was told they were drained of blood and reeked of decomposition.

The Malaysia Airlines Boeing-777 was shot down Thursday, killing all 298 people aboard. The plane was flying 10,000 meters above an area where Ukrainian forces have been fighting separatist rebels. Each side accuses the other of downing the plane.

U.S. intelligence authorities said a surface-to-air missile brought down the plane, and U.S. Ambassador Samantha Power told the U.N. Security Council in New York on Friday that the missile was likely fired from a rebel-held area near the Russian border.

Girkin, also known as Strelkov and allegedly a former Russian military intelligence agent, said he couldn't confirm the information. But it's sure to add to the intense emotions surrounding the crash, with the rebels accused of shooting down the plane.

Fri, 07/18/2014 - 17:51 | 4975482 NOTaREALmerican
NOTaREALmerican's picture

I think I saw that movie.  

Fri, 07/18/2014 - 17:57 | 4975501 SafelyGraze
SafelyGraze's picture

NOTICE

Your letter of credit, formerly backed by copper, has been exchanged for a letter of credit backed by a metal substantially similar to copper but that may have some properties other than those exhibited by copper.

Also, it might be a mortgage-backed security.

Hope that's ok. It's all collateralizable assetness. No big deal.

actually, it's backed by a securitized exchange-traded forex leveraging vehicle. as if that matters.

Fri, 07/18/2014 - 18:04 | 4975526 Otto Zitte
Otto Zitte's picture

Don't worry, you'll land on muppets.

Fri, 07/18/2014 - 18:09 | 4975542 gh0atrider
gh0atrider's picture

fonestar told gh0atrider that with blockchain-technology there is never any doubt in collateral chains on who owns what.

Fri, 07/18/2014 - 18:14 | 4975561 Harbanger
Harbanger's picture

Harbanger told fonestar to enjoy his new ruger 22.  He owns it.

Sat, 07/19/2014 - 18:15 | 4978097 mjcOH1
mjcOH1's picture

"Your letter of credit, formerly backed by copper, has been exchanged for a letter of credit backed by a metal substantially similar to copper but that may have some properties other than those exhibited by copper."

So hydrogen then.
Gaseous at stp.
What could go wrong?

Fri, 07/18/2014 - 18:16 | 4975566 logicalman
logicalman's picture

Can you show me the collateral backing BitCoins, please.

Fri, 07/18/2014 - 19:51 | 4975837 logicalman
logicalman's picture

Who owns what......

The guy with the biggest band of paid paid thugs.

That's a clue.

 

Fri, 07/18/2014 - 19:58 | 4975856 DoChenRollingBearing
DoChenRollingBearing's picture

While we (our bearing import company in Peru) are not familiar with Letters of Credit (LCs) that are collateralized like these out of China, there is great peril that there may be a contagion among LCs and their banks that would do grave damage to world trade (if LCs then become loaded with doubt among suppliers).

We do not even use LCs (they cost at least 1%, each 1% of a bearing's costs matters in Peru), we depend on TRUST with our suppliers in Asia, we pay then, then they ship.

Sat, 07/19/2014 - 07:48 | 4976639 JoeSoMD
JoeSoMD's picture

You must have a relationship with your suppliers then, or some low cost way of surveiling the status of your order.  We used to have low volume contract manufacturers and customer in Asia but neither party would do business without LC's because the cost of surveilance/monitoring prior to stage and/or final payment was way, way higher than the cost of LC's, we had not relationship, etc. 

Sat, 07/19/2014 - 07:49 | 4976641 JoeSoMD
JoeSoMD's picture

You must have a relationship with your suppliers then, or some low cost way of surveiling the status of your order.  We used to have low volume contract manufacturers and customer in Asia but neither party would do business without LC's because the cost of surveilance/monitoring prior to stage and/or final payment was way, way higher than the cost of LC's, we had not relationship, etc. 

Sat, 07/19/2014 - 09:42 | 4976723 Urban Redneck
Urban Redneck's picture

There actually is a fuck-ton (or more) of precedent for this, both in the shadow as well as the official banking sector in China. (About the only good thing I got out of that Simon Black shit piece was a good memory jog)

The Chinese have a very long history of raping, pillaging and plundering their own environment, in order to facilitate excess production of iron and copper, which is then warehoused in order to additional create paper money both receipt (starting @8th c.) and legal tender (starting @11th c.) - since iron and copper are the traditional backing/barbarous relics of Chinese money and banking (as opposed to gold and silver for the PM pumper clowns).

Take any prognostication that ignores the great RINSE, REPEAT machine with a grain salt (aka white gold).

Anyone lurking here with a PhD in Middle Imperial Chinese Finance History?

Fri, 07/18/2014 - 18:03 | 4975522 RaceToTheBottom
RaceToTheBottom's picture

I don't know about you but I hate it when I have to sit next to a dead guy.  It wrecks the whole flight.

Fri, 07/18/2014 - 19:45 | 4975777 Winston Churchill
Winston Churchill's picture

The live one are unually more offensive.

At least a corpse doesn't elbow you for the whole flight. and there is no overstuffing

of the overhead luggage compartment to worry about.

Nose plugs are a small price to pay.

Fri, 07/18/2014 - 20:22 | 4975930 SunRise
SunRise's picture

Hurts both ways: Just imagine the envy the dead guy feels toward you!

Fri, 07/18/2014 - 18:25 | 4975589 1stepcloser
1stepcloser's picture

Weekend at Bernies Remake in the offing.. 

Fri, 07/18/2014 - 20:19 | 4975924 SunRise
SunRise's picture

Raining caskets out of the cargo bay?

Fri, 07/18/2014 - 17:49 | 4975480 NOTaREALmerican
NOTaREALmerican's picture

Is this the same country starting the new Reserve Currency?

Fri, 07/18/2014 - 17:54 | 4975489 yogibear
yogibear's picture

First ones to fail financially are the first ones to recover.

-----------

"was likely fired from a rebel-held area near the Russian border."

WTF speculation? "was likely", like maybe. Assumptions cause wars.

Do we have a bunch of college kids running the white house?

Fri, 07/18/2014 - 18:17 | 4975568 logicalman
logicalman's picture

Probably be an improvement.

Fri, 07/18/2014 - 18:31 | 4975607 BlindMonkey
BlindMonkey's picture

Nope. An Indonisian duffer/fluffer has the keys to the place.

Fri, 07/18/2014 - 17:59 | 4975500 NoDebt
NoDebt's picture

I really want the Tylers to be right about this.  But it's taking for freakin' ever.

What I take from this article:  The Tylers have now stated we are at the point where things will "unwind rapidly," if they are, in fact, going to unwind in a contagion-type manner.  

It's July 18th around 6:00pm.  Make a note of it.

Fri, 07/18/2014 - 18:11 | 4975554 NOTaREALmerican
NOTaREALmerican's picture

Well, rapidly as measured in Fed Years.   1 Fed year = an unknown number of human years.

Fri, 07/18/2014 - 19:38 | 4975795 Winston Churchill
Winston Churchill's picture

Sunday evening open in the far east.

Still 7/20 here.All the numerologists were saying Lagarde was signalling

7/20 for the collapse.

Note to self.hit bank in am.

Fri, 07/18/2014 - 22:13 | 4976244 garypaul
garypaul's picture

NoDebt, the Tylers predict something like this at least twice a week, every week.

Fri, 07/18/2014 - 18:02 | 4975520 Yen Cross
Yen Cross's picture

 What the  F#@$k?    That means I can't triple rehypothecate unobtanium and unicorn livers anymoar.

  Baltic Dead index

Fri, 07/18/2014 - 18:08 | 4975538 Osmium
Osmium's picture

Dry Index 52 week range.  732 - 2337.

 

Nope, no problem there.

Fri, 07/18/2014 - 18:14 | 4975559 atomicwasted
atomicwasted's picture

Yeah you can.  PM me and I'll send you out some unicorn livers.  I'll need the money up front, though.

Fri, 07/18/2014 - 18:34 | 4975613 BlindMonkey
BlindMonkey's picture

Will you take a Chinese Letter of Credit?

Fri, 07/18/2014 - 19:58 | 4975853 mt paul
mt paul's picture

trade you

some fermented walrus flippers

 

for some of those unicorn livers..

Fri, 07/18/2014 - 18:19 | 4975573 logicalman
logicalman's picture

I think the copper in those warehouses was alchemically transmuted into unobtainium.

 

Fri, 07/18/2014 - 18:28 | 4975598 goldhedge
goldhedge's picture

MPNET Fags STRONK.

Fri, 07/18/2014 - 18:38 | 4975625 NoWayJose
NoWayJose's picture

Isn't rehypothecation the same thing the US has done with its own gold?

Fri, 07/18/2014 - 19:39 | 4975798 Winston Churchill
Winston Churchill's picture

What gold ?

Fri, 07/18/2014 - 18:43 | 4975640 sosoome
sosoome's picture

If there is much less collateral in the system than the system purports, collateral will be in short supply and demand will be high? Hard to figure. Knee jerk reaction will be a sell off of collaterals (copper, etc)? (BDIY is sucking air at 732)... at which time may be a golden buying oportunity because short supply can only mean higher prices? 

Fri, 07/18/2014 - 19:18 | 4975737 malek
malek's picture

I thought the collateral chains were never there in the first place, but only now they start realizing that.

Fri, 07/18/2014 - 19:50 | 4975831 orangegeek
orangegeek's picture

love the exposure denial by Citi

 

you know that's a lie

 

if HSBC stopped laundering cash for the cocaine dealers, maybe they could help out here

Sat, 07/19/2014 - 09:52 | 4976741 goldhedge
goldhedge's picture

The CIA won't let them.

Fri, 07/18/2014 - 20:09 | 4975887 Eirik Magnus Larssen
Eirik Magnus Larssen's picture

Unsettling prospect. Breaking links in commodity collateral chains can quickly morph into systemic failure.

Fri, 07/18/2014 - 20:25 | 4975944 SunRise
SunRise's picture

Do you work close to this?

Fri, 07/18/2014 - 21:05 | 4976062 robertocarlos
robertocarlos's picture

By Sunday?

Fri, 07/18/2014 - 21:32 | 4976132 gratefultraveller
gratefultraveller's picture

The moment Zato believes thanks to MH17 they finally have the game in the hand the central pillar of their construction - money - collapses in slomo as the Chinese Black Swan has landet.

Sic transit gloria mundi

Fri, 07/18/2014 - 23:02 | 4976344 Paracelsus
Paracelsus's picture

Odd how this is ZH (Fight Club).  Didn't Brad Pitt in the movie go on about the people in the Airline Emergency cards have faces that looked stoned or dead? There was actually one of the episodes of the new Sherlock series where there was an airliner full of stiffs,designed to crash somewheres and blame someone.Art imitates life,or the other way around.This would obviously be TWICE someone has crapped on the Malaysian airlines.

A la 9/11 perhaps they should look for who has shorted the stock.

Tyler,bring back the snorg tees ads,s'il vous plait.Especially the sheila with outstanding cameltoe....

Fri, 07/18/2014 - 23:03 | 4976346 Paracelsus
Paracelsus's picture

Odd how this is ZH (Fight Club).  Didn't Brad Pitt in the movie go on about the people in the Airline Emergency cards have faces that looked stoned or dead? There was actually one of the episodes of the new Sherlock series where there was an airliner full of stiffs,designed to crash somewheres and blame someone.Art imitates life,or the other way around.This would obviously be TWICE someone has crapped on the Malaysian airlines.

A la 9/11 perhaps they should look for who has shorted the stock.

Tyler,bring back the snorg tees ads,s'il vous plait.Especially the sheila with outstanding cameltoe....

Sat, 07/19/2014 - 07:50 | 4976640 hugovanderbubble
hugovanderbubble's picture

HSBC is collapsed...everybody knows it

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