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China – Recent Events In Qingdao Port Highlight Risks In Commodity Trading/Financing.

5 September, 2014

 

Legal News & Analysis – Asia Pacific – China – International Trade

 

In early June this year, a Chinese metal trading company and its affiliates were reported to have been using the same stockpiles of metal commodities stored at Dagang, Qingdao Port, China for the purpose of collateralising multiple loans. This was discovered amidst an apparently unrelated investigation by the Government into the activities of a government official in Qinghai Province, and a trail led the investigators to this Chinese metal trading company whose boss was a close ally of this government official. The allegations are still being investigated and the severity of its impact remains uncertain at this stage; it is however believed that the losses/exposure that may be caused to the banks and commodity traders involved could potentially amount to billions of US Dollars.

 

We have recently received a number of enquiries from clients and are also acting for various sectors of the industry affected by the incident. This article seeks to provide a brief note of our understanding of the matter and the issues involved and to provide some preliminary comments from a risk management perspective.
 

Background

 

The incident centres around a Chinese company, Decheng Mining Ltd (a Qingdao-based metals trading company) and its parent company, Dezheng Resources Holdings Co., which are reported in the Chinese press and elsewhere to have procured multiple warehouse receipts in respect of each parcel of commodity, and to have on-sold such cargo on a landed basis to other commodity traders/banks and/or pledged these multiple warehouse receipts to obtain multiple financing from a number of international and Chinese banks against the same collateral.
 
The relevant commodities are stored in the bonded warehouses at Dagang Terminal in Qingdao Port, China, and are believed to include copper cathodes, alumina and aluminium.
 
If the allegation that there are pledges on multiple warehouse receipts in respect of the same parcel of cargo proves to be true, there could be more than one party claiming title to the cargo and the total amount of the physical commodities currently stored in the bonded warehouses in Qingdao could be significantly less than the total amount represented by the warehouse receipts.
 
We also understand that Chinese authorities have commenced official investigations against these two companies and the individuals controlling the companies and who are at the heart of the alleged fraudulent conduct.
 
In the meantime, we understand that the Chinese authorities have also ordered a complete shut-down of the relevant warehouses in Dagang Terminal in Qingdao pending the investigations.
 
Apart from the Chinese and international banks mentioned above, the incident may also have a severe impact on a number of major international commodity traders. Commodities contracts involving the sale and purchase of cargoes stored in warehouses in China are common mechanisms for short term finance. It is believed that a number of major international commodity traders traded with Decheng/Dezheng or their affiliates in respect of the commodities stored in the bonded warehouses in Qingdao (i.e. the ones involved in the scandal). If Decheng/Dezheng have, as alleged, procured multiple warehouse receipts in respect the same cargo, the international commodity traders who traded with Decheng/Dezheng or their affiliates could be in a similar situation as the banks in instances where they are, or will become, the owners of the cargo in the warehouses (by virtue of being holders of the warehouse receipts); and the warehouse keepers are not able to deliver the cargo because of the significant shortfall in the cargo quantity.
 

Legal Issues

 

The incident in Qingdao has resulted in very complex legal issues involving multiple jurisdictions. With the matter unfolding, the issues would potentially include:
 
  • criminal conduct;
  • criminal investigations and proceedings against Decheng/Dezheng and the individuals involved in the scandal;
  • claims against Decheng/Dezheng and/or their affiliates for the losses suffered by the banks/traders;
  • claims against the warehouse keepers (some are in foreign jurisdictions) who issued the warehouse receipts for delivery of cargo;
  • claims against Qingdao Port or the warehouse operators/keepers if they are also found to be involved in the issuance of the multiple warehouse receipts;
  • claims under the commodities trading agreements; and
  • claims under cargo insurance policies taken out by the relevant cargo interests with insurable interests.

 

Comment

 

The situation surrounding the incident in Qingdao is far from clear but it is without doubt that the incident is causing severe concerns to the domestic and international banking and trading industry in respect of the risks in the pattern of financing/trading of commodities being used.
 
The incident underscores the importance of ensuring that there are stringent and effective mechanisms in place to monitor and oversee the physical commodities which are collateralised for financing or are otherwise the subject of commodities trading agreements. It is also important, as always, to conduct necessary due diligence checks to ensure the credibility of the business counterparties and, in the context of the transactions in the present matter, the practices of the warehouses to be used for storing such commodities.
 
Ince & Co  

For further information, please contact:

 

Wai Yue Loh, Partner, Ince & Co

waiyue.loh@incelaw.com

 

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