By Enda Curran, Sarah Kent and Chuin-Wei Yap
HONG KONG--Chinese authorities raised concerns about the use of
gold to back loans, saying they had discovered billions of dollars
of "improper" transactions, as companies exposed to a separate case
of potential fraud involving copper- and aluminum-linked lending
discussed a deal to share the possible losses.
The Swiss trading house Mercuria Energy GroupLtd. is assisting
in brokering a deal with traders and banks to split any potential
losses linked to metals stored at the port of Penglai, in eastern
China, according to people familiar with the matter. Chinese
authorities are investigating whether metals stored at Penglai and
Qingdao, another eastern port, have been fraudulently used as
collateral for multiple loans.
The discussions come after China's National Audit Office said in
a report released this week that a check among 25 gold processors
uncovered 94.4 billion yuan ($15.1 billion) of loans linked to
potentially illegal gold financing. It said the loans, designed to
profit from interest-rate and foreign-exchange differentials,
resulted in combined profits of more than 900 million yuan for the
processors.
The office didn't disclose details of the gold-financing deals,
which it described as "improper," including who was involved with
them, how they were structured or why they weren't legitimate.
The wording of the statement, which referred to the gold
processors as engaging in "fictitious trade," suggested the deals
could be illegal. The agency didn't respond to a call for comment.
There is no evidence indicating the companies involved in the
problems at Penglai and Qingdao and the gold financing are
linked.
Geneva-based Mercuria, the company that is assisting in
brokering a deal at Penglai, is one of the largest commodities
traders in the world. It has long-standing links to China and a
metals-trading business there.
Foreign banks with exposure at Penglai include BNP Paribas SA,
Citigroup Inc., Standard Bank Group Ltd. and Standard Chartered
PLC, people familiar with the matter said. It isn't clear whether
Mercuria and other trading houses or banks have experienced losses
as a result of the alleged fraud.
If all sides agree on a deal at Penglai, it could prevent
disputes over who is liable for any missing collateral in a
situation clouded by uncertainty over which companies are exposed
and the size of the possible losses. At Penglai, the volume of
collateral involved is smaller than at Qingdao, these people
say.
The discussions over a possible deal have drawn mixed responses
from the banks. "I told our lawyers we are not interested," said
one person familiar with the matter.
Both Western and Chinese banks have lent hundreds of millions of
dollars to commodities traders in recent years, using copper, iron
ore, aluminum and other commodities as collateral.
Banks including Citigroup, Standard Bank and Standard Chartered
have previously acknowledged potential problems with commodity
financing in China but have given no further details. Peter Sands,
chief executive of Standard Chartered, told reporters Thursday that
the bank's preliminary assessment is that the matter won't have a
material effect on its financial condition.
State-owned Citic Resources Holdings Ltd. said this month that
about half of the alumina stockpiles it had stored at Qingdao port
couldn't be located.
Contributing to the uncertainty is the fact that the banks
haven't been able to access storage facilities at either port,
people familiar with the matter say. The two port operators haven't
provided any details about the status of collateral that has raised
concern among lenders, these people say.
In one instance, inspectors for the lenders had to take
photographs of aluminum stockpiles at Penglai from outside the
storage facility's gates, said one person familiar with the
matter.
The operator of Qingdao port has said Chinese authorities are
investigating an alleged fraud, but port official haven't commented
further. Penglai port officials declined to comment.
"It's the most complex issue I've ever seen. Just to figure
things out is going to be complicated," said another person
familiar with the situation.
Banks are also investigating the role potentially played by
metals trader Decheng Mining Ltd, which they say is at the center
of the probe. Executives at Western banks said they made loans to
entities linked to Decheng Mining and are now trying to determine
whether these entities issued more than one receipt for the same
collateral to back multiple loans.
Attempts to reach Decheng Mining haven't been successful. The
Chinese government hasn't commented on its investigation.
The auditor's report on gold financing covers a period that
begins in 2012, but it didn't clearly specify the time frame.
Analysts say banks have begun to tighten supervision over
gold-backed financing in recent months, suggesting that lenders may
have been warned about the loans.
In a typical gold-backed financing deal, as described by
analysts, a manufacturer on the mainland would obtain a letter of
credit from Chinese banks backed by imported gold held in bonded
warehouses on the mainland or Hong Kong. The manufacturer would use
the letter of credit to raise a U.S. dollar loan from an offshore
bank, usually via an offshore subsidiary, which is then converted
into Chinese renminbi and reinvested in higher-yielding financial
instruments on the mainland.
The deals hinge on profiting from differences between the
interest rates on the dollar-denominated loan and funds invested in
China. Traders have used metals as collateral to bring some $110
billion into China since 2010, Goldman Sachs Group Inc.
estimates.
Write to Enda Curran at enda.curran@wsj.com, Sarah Kent at
sarah.kent@wsj.com and Chuin-Wei Yap at chuin-wei.yap@wsj.com
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