Mercuria and Citi slug out exposure to China metals fraud

The fallout from the metals financing scandal in China continues to be felt, with Citigroup and Mercuria, one of the world’s biggest commodities traders, wrestling over exposure to a $270m financing agreement in a London court.

Faced with the prospect of large losses, banks and traders have been scrambling to limit their losses on metal-backed lending deals in northeast China after local authorities started to investigate claims of fraud three months ago at two ports.

Large quantities of copper, aluminium and alumina stored at Qingdao and Penglai are alleged to have been pledged multiple times as collateral for loans by a subsidiary of a company called Dezheng Resources.

Mercuria started legal proceedings against Citi at a London commercial court in June after the US bank demanded the early repayment of a $270m repurchase agreement backed by metal held at the ports. Under a “repo” a trader sell metals to a bank with an agreement to buy back at a later date.

Citi also took delivery of a short hedge position as part of the deal. This was showing a loss of $24m at the end of July.

Citi responded by launching a counterclaim, arguing that it had the right to close the repurchase agreement in light of the investigation and potential fraud, which it says qualifies as a “bring forward event”.

The US bank subsequently tried to expedite proceedings, according to court documents seen by the Financial Times. At at a hearing in London on Friday a judge ruled a trial should take place during the last week of November or early December, rather than 2015.

Citi declined to comment on the case. Neither the bank nor Mercuria have been accused of any wrongdoing in relation to the suspected fraud.

In a statement, Mercuria said the purpose of the proceedings was to determine the rights and obligations of both parties under “contractual arrangements” they have relating to metal affected “by the ongoing situation” in Qingdao and Penglai.

Mercuria said Citi currently holds the legal title to the metal and therefore should bear any risk relating to the repo. People familiar with the matter said some of the metal was purchased from Dezheng.

“Both parties want to deal with the matters in dispute as swiftly as possible and, to that end, at a hearing today [on Friday] Citigroup applied for an order that there be an expedited trial of the issues,” Mercuria said in a statement. “The judge took the view that the matter was sufficiently important to be expedited, provided that all issues can be properly dealt with at an expedited trial.”

Since the investigation began the two Chinese ports have been in lockdown and western banks and traders have found it impossible to assess their exposure to the alleged fraud.

“As long as the ports are closed nobody really knows what’s there and that’s the problem,” said one banker.

Earlier this month, Standard Chartered said it had set aside $175m to cover its exposure to the suspected fraud, while Citic Resources, the Hong Kong-listed trading arm of state-owned conglomerate Citic Group, is facing losses of about $40m after it was “unable to sequester” almost 125,000 tonnes of alumina from Qingdao. The warehousing arm of Trafigura, another commodities trader, has also been trying to determine its exposure to the suspected fraud.

The scandal has raised wider concerns over the security of metal in other warehouses in China and could make banks more cautious about lending to Chinese importers using commodities as collateral. But fears that other financing scandals would be uncovered and cause other stocks tied up in financing deals in Chinese warehouses to flood the market have so far proved unfounded.

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