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China warehouse probe may help LME

Keywords: Tags  Qingdao probe, China warehouses, LME, London Metal Exchange, China Securities Regulatory Commission, CSRC, Hong Kong Mercantile Exchange, HKEx Shanghai Futures Exchange

NEW YORK — An investigation into alleged fraud involving copper and aluminum at the Chinese port of Qingdao could be the trigger to push a network of London Metal Exchange warehouses across China back up the agenda.

The probe into alleged fraud relates directly to the possibility that warehouse receipts for metal stored in a section of the port were falsified and issued multiple times in order to raise capital.

While one can never say never, it’s a situation that would be highly unlikely to happen within the LME’s warehouse network, primarily due to LMEsword, the exchange’s system for recording the ownership of LME warrants.

With this system, warrants are essentially placed with a central depository appointed by the exchange, which records the particular warrants that are held on behalf of identified account holders. Each warrant is produced to a standard format and includes a unique barcode.

An account holder in LMEsword is able to transfer ownership of LME warrants by entering an instruction into the system.

Under LME regulations, all clearing members of the exchange must become account holders in LMEsword, and nonclearing members can apply to become account holders. In addition, nonmembers can apply for LMEsword participation, provided they meet certain criteria.

Faking the ownership of metal would therefore be pretty tricky.

Official storage of LME-registered metal in China would be a coup for the exchange and its warehousing system, which currently relies on storage in bonded warehouses like Qingdao that are exempt from duty payments. The other alternative is the warehouse network for a smaller group of metals products trade on the Shanghai Futures Exchange.

The LME doesn’t own or run the warehouses in its approved network that spans more than 38 locations across 15 countries. Instead, it approves and licenses companies to run them, including Baar, Switzerland-based Glencore Plc’s Pacorini Metals USA LLC; New York-based Goldman Sachs Group Inc.’s Metro International Trade Services LLC; and Amsterdam-based Trafigura Beheer BV’s Impala Terminals UK Ltd.

But the LME has for more than a decade tried—and failed—to secure the go-ahead for an eventual network of warehouses in China, the world’s largest consumer of base metals.

In 2008, a turn of events made LME warehouses in China a very difficult prospect to imagine.

A directive in July of that year by the China Securities Regulatory Commission (CSRC), the state regulator, asked domestic exchanges to closely watch deliveries at terminals and banned foreign exchanges from using mainland warehouses for contract-related deliveries.

The ruling, which wasn’t aimed at the LME, was understood at the time to be seeking to prevent the Hong Kong Mercantile Exchange from delivering against its planned fuel oil futures contract.

Then a couple of years ago, the CSRC softened its stance toward LME warehouses after lobbying by Chinese metals participants, including the Bank of China Ltd. But nothing has since materialized.

The LME’s owner changed in 2008—having been taken over by Hong Kong Exchanges & Clearing Ltd. (HKEx)—but warehouses in China have remained on the radar for the exchange (, March 22, 2012), with HKEx having indicated that it would work with authorities in the country to develop a network.

It would likely be a toss-up between LME warehouses in Shanghai or Beijing to begin with, depending on approval from port authorities at the two locations. If Shanghai is chosen, the port in Yangshan is the most likely destination for storage facilities.

Of course, the investigation at Qingdao might have the opposite effect—the CSRC might start to view metals warehousing as a potentially corrupt route down which it has no desire to go. But LME warehousing is an entirely different prospect, as the warrant system proves.

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