Legal fight chills metal trade after Qingdao port probe

HSBC joins the queue of global banks and trading houses in launching suits over their exposure to suspected financing fraud at Qingdao port

PUBLISHED : Monday, 04 August, 2014, 2:44pm
UPDATED : Tuesday, 05 August, 2014, 5:02am

As global banks and trading houses fire off lawsuits over their estimated US$900 million exposure to a suspected metal financing fraud on the mainland, the tangled legal battle to recoup losses is set to drag on for years and hinder a swift recovery in metal trade.

HSBC Holdings is the latest bank to launch legal action since Beijing started a probe into whether the firm at the centre of the allegations, Decheng Mining, used fake warehouse receipts to obtain multiple loans.

Several banks had already ditched their commodity trading divisions due to low returns. The scandal, centred on Qingdao port, means those remaining in the commodity financing business will have to consider their future, or at least bring in new controls on lending requirements.

It has also acted as a warning over murky business practices on the mainland and highlighted the difficulties of navigating the country's legal system for foreign firms, some of which have since frozen new financing business.

"In the next six to 12 months, the impact would likely be reduced appetite for lending on metal collateral," said Daniel Kang, Asia head of basic materials equity research at JP Morgan. "Copper imports may come under pressure in the second half, partly related to smaller traders going bankrupt."

Mainland imports of refined copper, the most widely used metal in financing, fell 8 per cent in June from a year earlier to a 13-month low as banks reduced lending for metals imports following the Qingdao probe, which was first reported at the start of that month.

Using commodities as collateral to raise finance is common on the mainland, but duplicating receipts to repeatedly mortgage the full value of an asset is fraud and could leave more than one creditor holding claims to the same collateral.

With multiple claimants, cross-country jurisdictions, involvement of state-owned entities and a separate corruption probe into Chen Jihong, the chairman of Decheng's parent firm, the lawsuits stemming from the alleged fraud are unlikely to be wrapped up soon.

"The problem is that court judgments attained outside China are not recognised on the mainland. Companies cannot simply take the judgments into China and have Chinese courts freeze assets," said William McGovern, a lawyer at Kobre & Kim.

Firms may also try to recoup losses through arbitration as the mainland recognises international arbitration awards, but that process typically takes at least two to three years.

"The other question is 'where are the assets?'" said McGovern. "Obtaining an arbitration award against a fraudulent entity is only valuable if the defendant's assets can be located and seized to satisfy the judgment."

In the Qingdao case, a problem for some Western banks trying to retrieve cash is that their contracts were signed with global warehousing firms acting as collateral managers, leaving them no direct way of claiming in Chinese courts.

To seek redress, some are teaming up with their collateral managers, which have local units holding contracts at the port.

"It's a strategic alliance," a source at a global warehousing company said. "The collateral managers have said to the banks: let's join hands to get the real enemy."

HSBC, Standard Chartered, Citi, Standard Bank, Mercuria Energy Trading and Citic Resources Holdings have more than US$880 million of exposure in the case, according to company statements and reports.

In addition, state media reported on June 18 that mainland banks had a total exposure of about 16 billion yuan (HK$20.1 billion) on loans to Decheng and its related companies.

Chen, chairman of Dezheng Resources, the parent company of Decheng Mining, had been detained by the Communist Party's anti-corruption body as part of an unrelated corruption probe linked to state-controlled Western Mining Group.

He was only recently transferred to police custody in Qingdao for questioning, said a source who works at one of Chen's companies.

For Standard Chartered and HSBC, a resolution could take years, lawyers said.

Others hoping to lay claim on Dezheng's mainland assets would have to wait in line behind the mainland banks, they said.

"You can never fully protect against somebody who is all set out to cheat," McGovern said. "But you can protect yourself by doing thorough checks on both the individuals and the business and by using enforceable agreements, including having credible third-party guarantors who can assume the liability."