Why metals keep going missing in commodity trading

Trader Trafigura Group is facing more than half a billion dollars in losses after realizing that cargoes it bought didn't contain the nickel they were supposed to, sending fresh shockwaves through an industry that has been rocked by several high-profile frauds in recent years. In August, a group of Chinese merchants found that a copper trader in the nation wasn't holding almost $500 million worth of ore that was meant to be their collateral. And there was a June episode involving missing aluminum. They all highlight rising risks in commodity financing and carry worrying echoes of a much bigger scandal in 2014 — the Qingdao fraud — that triggered a sweeping overhaul of the commodities business at international banks and trading houses.

1. How could a stockpile go missing?

Risk and fraud stretches back through the history of commodities trading and there are several ways things can go awry. But at the heart of the issue is the sector's reliance on paperwork to back the shipment and storage of expensive cargoes, making it an easy target for fraud. Dealing commodities is typically a high-volume, low-margin business and merchants take out loans backed by the product they're trading to fund purchases and optimize cash flow. In metals, that collateral is often underpinned by paper records — warehouse receipts and shipping documents recording details like quantity, quality, ownership and location of the goods. The problem is that they can be faked, using fictitious material, or a single cargo can be collateralized for multiple loans — often known as over-pledging. In other cases, a stretched trader might simply sell on the goods to which the lenders have a claim, without paying back the loan.

2. What happened with the nickel?

Nickel is a popular metal with fraudsters due to its high value, with a single container potentially worth $500,000. Trafigura had been buying the metal that was in containers already on ships, then selling it on when the vessels reached their destination. But when investigators checked the contents of a container at Rotterdam in December, they found it was full of much lower-value materials. The discoveries have left Trafigura facing a $577 million loss from the containers.

3. What about the copper incident?

That case involved a modest-sized merchant called Huludao Risun Trading Co. The firm buys copper concentrate from international suppliers and stores it at port before sending to Chinese smelters. Last year, the company got loans from a syndicate of more than a dozen mostly state-owned firms, backed by 300,000 tons of Risun's stockpiled copper concentrate. The lenders learned that Risun was under financial stress, and when they went to check their collateral on site, they found only 100,000 tons — a third of the pledged amount. The rest had already been shipped out, violating the lenders' claim on the material.

4. And the other cases?

Several Chinese traders claimed they were duped into providing credit of up to 500 million yuan ($74 million) against fictitious quantities of aluminum. Suspicions that warrants had been tampered with led to multiple warehouses briefly shutting operations. Trafigura and commodities giant Glencore Plc were among those that rushed to audit their exposure, and at least one creditor sued the warehouse managers seeking compensation. Two executives of a British steel-trading business were this year found guilty of fraud in a $500 million trade-finance fraud scheme, and in 2020 Mercuria Energy Group Ltd. bought copper from a Turkish supplier but found containers of painted rocks. 

5. What's driving this?

In China, traders running on thin margins have faced ever tougher financing conditions over the past year or so as credit flows weaken. Banks are more cautious about lending due to the property downturn there and big swings in commodities prices fueled by the war in Ukraine. High-profile losses in the nickel market added to jitters. That's encouraged a turn to alternative and more lightly regulated financing — such as transactions in which smaller private firms pledge goods to large state-run traders for cash. 

6. What brings such cases to light?

Industrial metals crashed in mid-2022 on global recession worries, after reaching record highs in March. Such volatility can leave some market players with steep losses. The economy in China, the largest user of metals, is also struggling with a prolonged property crisis and uncertainty after it dropped its Covid Zero policy. So creditors have become more alert to risks around loans to commodities traders, who during downturns will have less cash flow and may become vulnerable to losses.

7. What are the potential consequences and answers?

In the worst case, there could be a crisis of confidence in key commodity supply chains. Banks and larger traders won't lend to smaller players if they're not confident that loans are secured by valid shipping and storage documents. More cases of missing metal could trigger deeper liquidity crunches that seize up metals trading or cause serious distress for big traders. One solution could be for the industry to go digital, which promises to reduce risks, cut costs and save time. But there's still no universally accepted standard that could replace the current paper-based system.

8. What happened in the Qingdao scandal?

In the Chinese city of Qingdao in 2014, it was banks, including international institutions, that ended up with the biggest exposure to a merchant trading firm and its affiliates that had pledged the same metals stockpile multiple times to obtain loans of more than 20 billion yuan. That made the banks more cautious. China's regulator also urged them to strengthen oversight, and the use of metals as collateral for financing has since diminished. Outside China, French and Australian banks got hit by loan losses in 2017 that totaled over $300 million after they discovered fake documents for nickel stored in Asian warehouses owned by Access World, a subsidiary of Glencore. In 2020, Singaporean oil trader Hin Leong (Pte) Ltd. forged documents to win trade financing for products it had already sold. A few years ago, Russia's Sberbank PJSC was said to discover that containers of nickel in Rotterdam that it financed on behalf of Sanjeev Gupta's Liberty Commodities had already been emptied. 

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.