LME WEEK 2016 - LMEshield initiative could revive Chinese metal financing

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Vivian Teovivian.teo@fastmarkets.comJoint News Editor - Asia

Singapore 01/11/2016 - An LMEshield pilot programme in China could inject life into the country's stagnating metal-backed financing trade but a more conducive macroeconomic environment will be needed for a full revival, market participants said.

The London Metal Exchange announced on Monday October 31 a one-year scheme which will see Henry Bath issue receipts on LMEshield, a central electronic register for the creation and transfer of off-warrant warehouse receipts, Metal Bulletin previous reported. Receipts will initially be issued for bonded warehouses in Shanghai but could be expanded to other Chinese locations in the future.

Once the pilot programme ends, the LME also intends to work with other warehouse companies and Chinese regulators to facilitate the expansion of the initiative.

“This could potentially take off in China and could boost metal financing trade flows,” a Guangzhou-based metals analyst said. “There is a lack of standardised warehouse receipts in China. Banks and traders will see the LME’s warehouse receipt system as being more reliable.”

The initiative could provide a shot in the arm to metal-backed financing business in China, which has dropped significantly over the past year or two primarily due to difficulties obtaining letters of credit (LCs) from banks.

The industry had been rocked by the Qingdao fraud scandal - warehouse receipts there were used multiple times to secure multiple loans against the same metal stocks stored at the Shandong port.

Financing business and metal trading volumes has since stagnated in China - banks slashed credit lines to trading companies, especially for repo deals using bonded-warehouse receipts as a deposit against loans, sources said.

Most have cited the LME's reputation and credibility as crucial factors that could help revive the banks' confidence in financing metal in China. This is a major selling point that Charles Li, the CEO of LME parent Hong Kong Exchanges & Clearing (HKEX), has made for LMEshield.

LMEShield would be a great opportunity for banks – particularly Chinese banks – to return after Qingdao essentially shut down a lot of financing activities, Li said at a press conference in August.

“Now those activities are likely to come back and LMEshield is going to play a very important role in revitalising that effort,” he said.

The warehouse receipt initiative is designed to improve confidence in global off-warrant warehousing, increase fraud prevention controls, enhance efficiency of transfer of ownership and support and expand the market for financing of off-warrant commodities, the exchange has said.

OTHER FACTORS AT PLAY

Chinese firms in the private sector are experiencing tight cash flows; some could be interested in entering metal trade financing again because the LMEshield system could boost confidence in the industry, a Shanghai-based trader said.

But some market observers are sceptical about the ability of LMEshield to trigger a revival in metal-backed financing in China - not least of all because the financial landscape has changed over the past two years, a Beijing-based metals analyst pointed out.

Not only has Beijing enforced a clean-up of the sector after Qingdao but domestic banks and warehouses have also become stricter on metal trade financing requirements, she said.

“There are more factors at play like global interest rates, currency fluctuations and metal prices other than just having reliable warehouse receipts,” she added.

The overall macroeconomic environment has not been conducive for metal financing, which is likely to remain the case - the yuan is expected to weaken further and interest rates in China and the US are seen moving in different directions, the analyst also noted.

China has held its one-year benchmark interest rate at a record low of 4.35% for a year while the US is widely expected to raise interest rates in December.

Traders had been able to profit from the interest-rate arbitrage between China and the rest of the world by borrowing in dollars at low international interest rates to buy copper and then using the metal as collateral to get LCs from Chinese banks.

Traders would then use these to issue credit to local businesses, essentially profiting from low offshore rates, higher Chinese rates and the difficulty of obtaining credit in the country.

Low copper prices have also cut profit margins for copper-backed financing, making such transactions less attractive for traders, sources pointed out.

The London Metal Exchange three-month copper price has largely traded below $5,000 per tonne over the past year – it was recently at $4,879.50 per tonne on Tuesday, up $26.50 on Wednesday's previous close.

“I’m not optimistic that this trade can be revived. I expect things to remain [the same] next year,” the Beijing analyst added.

Metal trade financing in China is at least unlikely to dip much further from current levels, a Shandong-based metals analyst said.

“Those who used to operate this business have either collapsed or have exited this area. Those who remain are relatively stable companies,” he added.

But uncertainty over the future direction of the yuan could also weigh, he noted.


(Additional reporting by Kathleen Retourne, editing by Mark Shaw)



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