The current scandal surrounding warehoused metals at the Chinese port of Qingdao has unveiled a worrying level of collateral risk. Jeff Milligan (Principal Consultant, GFT) notes that double-pledging of financial collateral is now being addressed by worldwide regulators. Furthermore, Milligan comments that, in the case of the Qingdao loans, these collateral arrangements outside of the financial system infrastructure pose severe risk, with metal lying in a murky business environment of China.
As worldwide regulators address the double-pledging of financial collateral that surfaced during the financial crisis, Milligan warns banks that in China, collateral arrangements are still outside the infrastructure of the country's financial system.
The allegations that a trading company in Qingdao took out numerous loans based on the same collateral, in the form of copper and aluminium stored in warehouses, raises concerns that other Chinese companies may have also misused collateral. These loans come on the back of a surge in offshore borrowing by Chinese companies, with Goldman Sachs Group Inc. estimating that $110 billion of foreign exchange which has entered China over the last four years was tied up in this type of lending.
Milligan believes that banks have two options when considering making such loans: the first is to "know your clients very, very well" and establish a "bona fide way internally of investigating" the collateral; the second would be "don't do it at all."
The above commentary from Jeff Milligan was featured in an article in The Wall Street Journal, on 16 June 2014.