A warehouse fraud at China's third-largest port has forced banks and trading houses to consider new controls in the country's massive commodity financing business, which traders say could lead to drying up of credit for all but large firms and state-owned companies.
On Thursday, Standard Chartered Bank, a major foreign provider of such finance deals, become one of the first firms to put a dollar figure on its activities, saying its commodity-related exposure around the port was about $250 million, although not all of that was at risk.
"That is across multiple clients, multiple locations, multiple types of facilities, not all of which will be affected," Chief Executive Peter Sands said on a conference call.
China's commodities trading is dominated by the large and state-owned companies but there are thousands of small firms in the market. Faced with tougher bank requirements for financing, they could sell down stockpiles, squeezing demand for metals and other raw materials such as rubber in the world's biggest consumer of commodities.
Any new requirements would also ratchet up the risk that customers who do not regain credit lines may default on payments for services such as hedging, or for imports.
"The fear is not so much about the big boys, but some of the other smaller, newer players, who may have only been in this commodity financing game for the last two to three years," said Jeremy Goldwyn, a director with commodities broker Sucden in charge of Asia business.
"If all of a sudden the tap is turned off to them, they might have more of a crisis. Is it having an effect on the market? Yes, people are very nervous. We obviously have a lot of business in China so we are watching it very closely," he said.
According to sources, Standard Chartered Bank has suspended some commodity financing deals in Qingdao port after authorities there launched a probe into a private trading firm, Decheng Mining, that is suspected of duplicating warehouse certificates to use a metal cargo multiple times to raise financing.
A Standard Chartered spokesman in London said the bank was reviewing its exposure to commodity financing but was not "pulling back" from that type of business, or from China itself, which remains a "key market".
For Western banks such as Standard Chartered, HSBC and BNP Paribas, which are restricted in the domestic loan market in China, the metals financing business is a lucrative alternative but the Qingdao scandal has renewed focus on counterparty risk.
Goldman Sachs estimates that commodity-backed deals account for as much as $160 billion, or about 30 percent of China's short-term foreign-exchange borrowing.
Besides metals, the banks are now taking a fresh look at loans backed by other commodities such as iron ore, soybeans and rubber, fueling concerns that any drying up of credit could spark a series of defaults on trade loans, or force other cash-strapped firms to cancel term shipments in the second half of this year.
"In the next two months, some smaller companies may default on term copper shipments if they cannot receive letters of credit or if they can't find a bank to do inventory financing," said a trader at a large international trading house.
As they review their commodity lending business, some foreign banks are considering measures such as getting finance guarantees from Chinese banks for letters of credit issued to local firms and taking on insurance with more comprehensive coverage, bank sources said.
"If we are signing contracts with their Singapore or Hong Kong-registered company, we may also start demanding guarantees from the Chinese parent," said an executive at a Western bank affected by the port scandal.
In the case of Decheng, there are worries among exposed banks that they would have difficulties recovering the losses because most of the financing agreements were signed with its Singapore-registered unit, which has limited assets to pay back creditors, said the executive.
Neither Decheng Mining, nor its parent Dezheng Resources, could be reached for comment.
Weeding out smaller firms
For smaller end-users and trading firms, both local and Western banks are also thinking of imposing loan restrictions that will require shippers to prove that they already have domestic buyers lined up for the metal, sources said - a move that could weed them out of the commodity financing business as they struggle to meet these tougher requirements.
These measures are set to make commodity financing in China - already under scrutiny by authorities - even harder and costlier, in turn helping large players, such as state-owned Chinese firms and large end-users, get even bigger.