Security has become concern for banks that finance commodities since financing controversy
The London Metal Exchange has struck a deal with one of the China’s biggest logistics companies to use its electronic warehouse receipt system, as the 139-year-old bourse looks to capitalise on growing concerns about falsified documents.
In the first phase of the agreement, China Materials Storage and Transportation Development (CMSTD) will list one of its warehouses as an LME Shield facility along the Maritime Silk Road, which runs from China through Southeast Asia.
Seven banks have agreed to support the financing of stocks held at warehouses along the route, with Mercuria, one of the largest commodity traders, set to deposit metal.
The security of warehouse receipts has become a concern for banks that finance commodities since an alleged fraud in China caused hundreds of millions of dollars in losses for big banks.
In the eastern port cites of Qingdao and Penglai, warehouse receipts were allegedly used multiple times as collateral in deals known as sale and repurchase agreements, important financing tools for commodity traders.
That highlighted the shortcomings of systems’ lack of a secure depositary for receipts and an electronic audit trial. Some Chinese banks approached the LME to ask about using their system in more locations around the world, according to a person familiar with the exchange.
Han Tielin, CMSTD chairman, said the use of LME Shield would provide “great confidence to the metals community, especially to financing banks in light of recent metals financing frauds”.
CMSTD has been charged by Beijing with building a network of commodity warehouses outside the country.
To spearhead its international expansion drive, the state-controlled group bought this year a majority stake in Henry Bath, the 221-year-old metals warehousing business own by Mercuria.
The “One Belt, One Road” policy, launched by Xi Jinping, Chinese president, aims to boost investment and trade along a land route linking central Asia, Russia and Europe. A sea route is expected to go through Southeast Asia and the Indian ocean.
Analysts say the policy could spur demand for metals and commodities in countries along the route as China steps up investment projects. It could also boost exports of metals and materials from producers in China that are struggling with excess capacity.
Last year the LME and a group of Chinese banks agreed goals to support the initiative. These included: price convergence between Chinese and global markets, the use of LME-approved warehousing systems on established trade routes and assisting the internationalisation of the renminbi.
The LME, which is owned by Hong Kong Exchanges and Clearing, is looking for ways to license its system of receipts, or warrants as they are more commonly known, to companies operating warehouses outside its network.
In the case of some metals such as aluminium, “off warrant” storage dwarfs the number of tonnes held in LME-licensed warehouses. Greater use of the LME’s system could make these stocks more transparent.
A test would be whether banks accept Shield receipts as collateral for short-term loans, said traders.