Citigroup Was Wary of Metals-Backed Loans
Bank Forged Ahead in a China Commodities Market Now Roiled by Fraud Allegations
CHRISTIAN BERTHELSEN and SARAH KENT
Updated Dec. 21, 2014 7:54 p.m. ET
LONDON— Citigroup Inc. pushed forward on a series of ill-fated metal financing deals in China despite internal warnings about the risks, leaving it exposed to losses that could take a big bite out of its growing commodities business.Senior executives at Citi were wary of an internal proposal first made in 2011 that it start lending to clients using metals stored in Chinese warehouses as collateral, people familiar with the discussions said. The bank still decided to enter China’s booming metal-financing market in 2012 and quickly expanded its lending to certain key clients.
The move was part of the rapid growth of Citi’s commodities trading business. Citigroup has made an aggressive push into raw-materials markets in the past two years as other banks have retreated amid declining returns and increased regulatory scrutiny. The bank has poached employees and trading books from rivals, including BNP Paribas SA, UBS AG andDeutsche Bank AG . The drive has mostly been a success: Global commodity revenue grew to $486 million in the first nine months of 2014 compared with $277 million in all of 2013.
However, allegations made earlier this year by lenders and traders of a huge fraud at two Chinese ports where Citi held substantial metal stocks seem to have vindicated some of the early concerns. Citi is one of several Western banks and trading houses that could now face losses after it emerged that Chinese authorities were investigating whether a local trading firm fraudulently used the metal to secure multiple loans. The companies are tangled in a web of lawsuits stretching from Hong Kong to London as they scramble to limit their exposure.
Citi’s position amounts to about $270 million of copper and aluminum it bought from Swiss commodities trader Mercuria Energy Group in a series of transactions since May 2013, with an agreement to sell the holdings back later at a higher price, a form of secured low-cost loan that bankers term a repo, according to evidence presented in London’s High Court during a December hearing in a lawsuit between the companies.
Neither company has been accused of wrongdoing in the alleged fraud, but the metals’ uncertain status led Citi to demand early repayment on the deals in June. Mercuria is challenging Citi’s demand. Citigroup has already taken a provision against third-quarter results for the deals, but anticipates prolonged legal proceedings before it can fully account for the value of its position, according to a person familiar with the situation.
In mid-2011, Robert Bayley, Citi’s then-head of Asian commodities, proposed entering the Chinese commodity-backed repo market to senior commodities executives at Citi globally, people familiar with the situation said, saying the bank could generate profit from this low-margin, high-volume business.
Mr. Bayley also highlighted potential risks, including the difficulty of enforcing contracts in China and exposure to fluctuating commodities prices.
During a conference call, he made his case. The discussion was brief, but vigorous. Executives from Citi’s metals team were skeptical the bank would be able to recover, or even find, the metal warehoused in China in the event of a default, the people said.
Stuart Staley, the head of Citigroup’s commodity business, said the proposal needed more analysis, according to the people familiar with the discussion. But he and other executives eventually decided to go ahead with the plan after structuring the business in ways that they thought would curtail risk, including doing business only with Western trading houses that were already clients, and to screen the warehouse operators with which it dealt. In June 2012, Citi financed its first stockpile of Chinese metal and began rapidly ramping up its business.
In an emailed statement, Citi spokesman Simon Boughey said the bank decided to pursue the business after an “extensive internal review process.” He said the business was carefully structured to reduce risks to the bank. Mr. Bayley wasn’t available to comment.
In October 2013, Citi hired Georgina Baker, a veteran of China’s metals-financing trade, from Standard Bank. In the following months the bank raised the metals-backed financing it was prepared to extend to Mercuria to $500 million from $100 million, according to Ms. Baker’s court testimony, making the trading house one of its most significant customers for this product.
By this spring, financing deals between Mercuria and Citigroup were valued at more than $400 million, backed by metals stored at giant warehouses in the ports of Qingdao, Penglai and Shanghai.
Ms. Baker was on holiday in late May when she received a phone call from her colleague Aidan Shilling, court filings show, informing her Mercuria had notified the bank of a possible problem with Citi’s metal stored at Qingdao.
News trickled out through the banks and trading houses with metal stocks at the ports that a major metal supplier, Decheng Mining Ltd., had allegedly pledged stocks of metal stored at Qingdao and Penglai several times over to secure multiple loans. The Chinese authorities opened a fraud investigation and locked down warehouses in the ports, according to Western banking executives and port officials. The Chinese government hasn’t commented on the matter.
Decheng wasn’t available to comment.
Citi executives eventually learned Mercuria had obtained virtually all the metal underpinning its deals with the bank from Decheng, Ms. Baker testified.
“Panic is a relatively emotive word, but there was certainly a lot of discomfort when you receive a call from a client, saying that potentially $250 million of goods that you expect to be in a certain location may not be there or may be pledged elsewhere,” Ms. Baker said in court.
Citi began sending daily reports to senior managers and alerted U.S. and U.K. regulatory authorities to the alleged fraud, evidence presented during trial showed.
The bank decided to demand Mercuria buy back the metal early. The trading house responded with a legal challenge to the bank’s right to early repayment.
Mercuria eventually claimed the uncertainty surrounding the metal gave it the right to suspend payments related to the transactions. Citi delivered warehouse receipts representing the metal under dispute back to Mercuria and initiated a counterclaim for repayment of the roughly $270 million plus interest.
The case was filed in U.K. commercial court in June.
Mercuria has alleged in court that Citi intended to use its “commercial muscle” to coerce the trading house into absorbing any potential loss. It alleged Citi had always known Decheng was the source of its metal, particularly given a long-standing relationship between Ms. Baker and Chen Jihong, the owner of the Chinese trading house.
Ms. Baker acknowledged under examination by Mercuria’s lawyer that she did business with Mr. Chen’s company for eight years at Standard Bank before joining Citi, that she attended a party and numerous dinners where he was present, and received a $15,000 watch from him for her birthday in 2012. However, she denied knowing that Mr. Chen was the source of Mercuria’s metal.
The Qingdao and Penglai ports remain closed and the status of the metal is uncertain. A ruling in the case between Mercuria and Citi is expected early next year.
Sinotrans stock plunges on fraud fears
Wednesday, 05 November, 2014, 5:23pm
Chim Sau-wai firstname.lastname@example.org
State logistics firm suspends share trading after media reports of fraudulent inventory management at subsidiaries on the mainland
Shares in state-owned logistics firm Sinotrans were suspended from trading on Wednesday after falling up to 27.9 per cent in the morning after the mainland media reported that subsidiaries of its parent company, Sinotrans & CSC, were involved in fraudulent inventory management.
Sinotrans said in a statement filed to the Hong Kong stock exchange that trading in its shares was being halted pending clarification of the media report.
The China Business News reported the person in charge of the Guangxi and Liuzhou subsidiaries of Sinotrans’ parent company had been detained by police for involvement in multiple pledging of the same inventory as collateral for bank loans.
The report said mainland Sinotrans & CSC subsidiaries were involved in inventory management problems, such as fraudulent accounts and missing inventories, and that the value of such “risky” inventories pledged as collateral and managed by the subsidiaries had exceeded 10 billion yuan (HK$12.67 billion).
The report, if accurate, would mean another major collateral financing fraud has been uncovered on the mainland, following the one discovered at Qingdao port in June.
The Qingdao financing fraud involved multiple pledging of the same stock of metals for loans. Industry experts said in many of the multiple pledging cases, logistics firms or warehouses acted as collateral manager of the inventory pledged for loans.
Shares of Sinotrans plunged as much as 27.9 per cent, the most since November 2008, to HK$4.26, then bounced back to last trade at HK$5.15, still 12.9 per cent lower than Tuesday’s close, before trading was halted. Trading volume surged to 212 million shares, more than the total of the previous two trading days combined.
The listed firm, 60 per cent owned by Sinotrans & CSC, agreed in February to provide management services to subsidiaries of the parent company, including those engaged in freight forwarding, shipping agency and warehousing in Guangxi and Henan.
In return, Sinotrans would receive management fees of 24.75 million yuan in total from this year to 2016.
A company statement filed with the stock exchange in February said Sinotrans would not be responsible for the profits or losses of the subsidiaries, which would be borne by the parent firm, but the arrangement offered the listed company the opportunity to assess whether it could acquire the subsidiaries.
Bocom International analyst Geoffrey Cheng said if the reported fraud was just related to the subsidiaries, the impact on the listed company might be limited to the loss of the management fees, but the report “reflects weak risk management of state-owned enterprises”.
Cheng said he was worried about the risks posed by such collateral management businesses. “Many logistics firms that we talked to said they had reduced the [collateral management] business after the Qingdao port incident,” he said.