Commodities market frauds; what’s broken, and how to fix it

In the first five months of this year, a series of frauds have rocked the commodities markets across the globe, and particularly in Singapore. Fingers have been pointed at the crisis in the oil market triggered by the virus pandemic. But what is interesting is that the modus operandi of the frauds have been fairly similar, and the victims have been usually banks and institutions providing trade finance.

The events have cast a pall over bank financing for the commodities sector. There have been calls for better regulation, but the problems may be deeper. Probably, the commodities market needs to revamp its systems and procedures, and introduce digitization, such as the blockchain, to plug loopholes that have been exploited by commodities traders over the years.

Agritrade International

In February, ING Bank alleged that Agritrade International, a Singapore commodities company, had committed fraud by issuing multiple “overlapping” bills of lading, or lists of shipment goods, to obtain financing from multiple banks for the same shipment. According to Commerzbank, it financed Agritrade shipments of coal that did not exist – after it hired a coal specialist investigator. A consortium of 15 lenders, including ING and Commerzbank, are on the hook for US$600 million of Agritrade International’s US$1.5 billion of liabilities.

Hin Leong Trading

According to the Financial Times, Singapore’s Hin Leong Trading revealed that it had sold oil pledged as collateral for loans to raise cash. The firm allegedly suffered $800 million in futures trading losses that were not reported in the accounts.

Zenrock – same modus operandi

Last month, HSBC alleged that Singapore-based oil trader Zenrock Commodities conducted fraudulent oil trades. The bank claimed that the firm secured financing from multiple lenders by pledging the same cargo of crude oil several times over and duplicating invoices with different payment instructions. HSBC said Zenrock had not repaid dues of around $50 million and that the trader’s overall liability to institutions was about $165 million.

2014 – China – Dezheng Resources

Chinese firm Dezheng Resources pledged warehouse receipts representing metal stocks at the Chinese port of Qingdao multiple times to obtain trade finance from banks. Though the firm was accused of this in 2014, and finally convicted too, lenders had to swallow losses of over $3 billion.

What can lenders do?

There are many suggestions, including:

• Strengthen due diligence
• Undertake physical spot checks of inventories
• Obtain personal guarantees from owners
• Understand the firm’s trade flows and balance sheet

However, for a long-term cure, these actions need to be supplemented by comprehensive digitization that tracks the complete lifecycle of a commodity transaction.

Digitization the need of the hour

“Unlike derivatives transactions, which are settled through clearinghouses, the physical commodity market lacks a digital confirmation facility where the pricing, payment and delivery terms booked by the buyer and the seller can be reconciled — automatically and in real-time,” says Etienne Amic in an FT opinion piece.

However, blockchain technology can be a game-changer. Digital confirmation is available to banks and lenders in respect of transactions, shipping, and payments.

How blockchain can help – examples

Chase Auto plans to digitize auto dealers floorplan lending by putting it on a private blockchain. Wholesale car financing, even of vehicles on dealership floors, will be accurate and in sync with actual physical car inventory. It will avoid the practice of “double-flooring,” when dealers fraudulently pledge the same cars with different banks.

China Merchant’s Port (HKG: 0144), the country’s largest port operator, is collaborating with Alibaba Group (NYSE: BABA), and its subsidiary, Ant Financial to develop a distributed ledger technology (DLT), or blockchain platform. The blockchain will connect the port’s trade and logistics flow and will allow exporters, importers, banks, customs authorities, and the tax department to seamlessly conduct all aspects of trade transactions.