Winter Park, Florida 21/11/2014 - Goldman Sachs, via its warehousing subsidiary, Metro International Trade Services, paid millions of dollars in incentives to metal holders to move aluminium out and then back into its own warehouses in what is now being called a 'merry-go-round' trade, the influential US Senate Permanent Subcommittee on Investigations has discovered.
Metro ultimately entered in six so-call merry-go-round deals with Deutsche Bank, Glencore and UK hedge fund Red Kite.
In each deal, Metro provided financial incentives to the owner of the aluminium stored in its warehouses to: wait in the queue; upon reaching the head of the queue, load out its metal from a Metro warehouse; deliver the metal to another nearby Metro warehouse; and warrant the metal while in the second Metro warehouse.
Not only did the Senate Subcommittee uncover the existence of these deals, it also released detailed e-mails and invoices that describe in detail the volumes, terms and exact incentives. Given the highly confidential nature of the warehousing business, this is a rare glimpse into how this business operates.
So here is an inside look at just one of the Red Kite deals. On November 1, 2012, Metro’s warehouse manager emailed Red Kite executives about a large amount of aluminium that the hedge fund was holding on warrant in Detroit in a financing deal with Barclays Bank.
“Thanks for approaching me with an opportunity to store approximately 150,000 tonnes of aluminium, which you are holding LME warrants for currently,” the Metro manager wrote to Red Kite in an e-mail that was an exhibit in the Senate Subcommittee report.
Metro then describes the proposed terms of the warehousing deal. Red Kite would immediately cancel aluminium warrants and place that metal in the Detroit queue. When it got to the front of the line, Red Kite would agree to have that metal moved to another nearby Metro shed, where it would be re-warranted.
Metro agreed to pay Red Kite cash incentives totalling $196 per tonne if the process was completed. If 150,000 tonnes made the entire loop, Red Kite would get $29.4 million in cash.
These cash incentives where divided into two components. When the warrants were first cancelled, Red Kite would receive an initial freight allowance of $36 per tonnes (LME FOT). The warehouse company would then pay another $160 per tonne when the metal was re-warranted in the second Metro shed.
In addition, Metro committed to discount the rent it would charge Red Kite at the new warehouse locations and pay the cost of shipping the metal from one warehouse to the other.
Red Kite did, however, retain the right to either sell the metal when it reached the front of the queue or move it to a warehouse company other than Metro. But if it did so, Red Kite would have to pay Metro $66 per tonne.
Broken down further, Red Kite would have to pay back the $36 freight allowance and a $30 per tonne penalty.
“We are in agreement with this,” responded a Red Kite executive in a November 4, 2012, e-mail. “RK will endeavour to reach 150 to 200kt; however, this will be done in smaller tranches as the spreads and market allow.”
Red Kite started cancelling warrants November 7, 2012. Over the next six weeks, the hedge fund continued to cancel warrants as the amount of aluminium included in the deal reached nearly 190,000 tonnes, the Senate Subcommittee report said.
Of the 190,000 tonnes covered by this arrangement, 182,000 tonnes was loaded out of Metro warehouses. Of that, about 160,000 tonnes simply went out of one Metro warehouses and back into another, the report said.
“Thus, nearly 90 percent of the metal shipped as pursuant to the deal went from Metro right back to Metro. Metro records show that, pursuant to this deal, Metro arranged for more than 4,300 truck shipments, moving the metal from some Metro warehouses to other Metro warehouses in the Detroit area, at a cost of more than $1 million,” the report said.
“That came on top of the $26 million that Red Kite billed Metro for incentive payments under the deal,” it added.