August 12, 2015 / 9:14 AM / 2 years ago

Yuan drop risks shake out in Chinese copper financing

* Copper-backed financing still popular in China

* But could be hit by devaluation of yuan

* May drag on international copper markets

By Polly Yam

HONG KONG, Aug 12 (Reuters) - Chinese importers using bonded copper stocks as collateral for short-term dollar loans face rising costs after the unexpected depreciation of the yuan, potentially forcing smaller firms to give up metal to banks for resale in the coming quarter.

China's yuan has declined roughly 4 percent so far this week and hit a four-year low on Wednesday, a day after authorities devalued the currency.

That's bad news for firms using copper-backed financing to raise funds in China, still a common practice due to restrictions on bank credit and despite greater scrutiny by authorities after a major metals financing scam last year.

People in the industry said the risk of copper being dumped could hit future imports, piling more pressure on international markets already grappling with oversupply and slowing economic growth in China, the world's top metals consumer.

London copper prices have fallen nearly a fifth this year, standing around $5,130 a tonne on Wednesday.

"Some importers who purely used the bonded copper as a financing tool to invest in other assets in China may default on repo loans in later months," said Zhou Jie, a trading manager at China International Futures in Shanghai.

The bulk of the currently more than 500,000 tonnes of bonded stocks in Shanghai is linked to financing deals. This is mainly in the form of re-purchase contracts (repos), with three to 12 months maturity, held by Chinese firms.

These dollar loans are mostly provided by foreign banks and must be hedged against London Metal Exchange prices for the metal, but hedging against the dollar-yuan rate is optional.

"In three to six months, it is possible some bonded stocks could be taken over by banks," said a manager at a large Chinese trading firm, declining to be named because he was not authorised to speak to media. He did not indicate the amount of stocks that could be hit.

But traders said the volume could be limited as banks had tightened repo requirements after the alleged metals scam at Qingdao port and many copper importers were now medium and big firms.

Bigger firms should be better able to absorb the losses and would not want to damage their relationships with banks, said an executive at an international trading firm.

Other companies that are yet to repay dollar-denominated letters of credit taken out to buy copper overseas would also be hit by the yuan's drop.

Meanwhile, traders said speculators had closed some arbitrage positions that were long on LME copper and short on Shanghai <0#SCF:>, a move which could cut potential imports in the fourth quarter. (Reporting by Polly Yam; Editing by Joseph Radford)

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