QINGDAO China/SINGAPORE (Reuters) - Is the metal stored in a Chinese warehouse really there? Has the peanut oil shipment a bank lent money against been swapped for worthless water?
Basic questions have begun to play on the minds of traders and bankers doing business in the world's largest raw material importer, after an investigation began at Qingdao Port, a huge trading hub in the northeast, into whether more than one licence had been issued against the same material.
The duplication, which leaves someone out of pocket when they claim what they thought was theirs, may be the result of deliberate fraud by a company using the same metal to raise multiple loans.
The case of Qingdao, the world's seventh-largest port, has yet to play out and could be an isolated problem involving one or a handful of companies, rather than endemic at ports.
But for many Western traders eyeing the gargantuan growth of China’s commodity demand, credit is a touchy issue that brings back memories of the 2008 financial crisis, making them especially jumpy when credit related issues arise.
On Friday, Qingdao Port said it had been asked by China's Public Security Authority to help with an investigation relating to aluminium and copper products under the name of a third-party cargo shipment agency on behalf of a cargo owner.
It did not say how much metal was involved, but said it was an "immaterial proportion" of its total annual throughput, and added that none of its employees were under investigation.
Yet in a country where oversight of commodity warehousing is generally accepted as weaker than in developed financial centres, the case is making people nervous.
Already, some copper cargoes being held at Qingdao are being shipped to warehouses outside the country that are regulated by the London Metal Exchange (LME), industry sources said, in what one trade executive called a "classic flight to quality".
"When we were there (in Qingdao), we did hear a couple of traders holding the same title," said an iron ore trader at a global trading house who was at the port in the last few days.
"One was saying that one (cargo) belongs to me, the other trader said it belongs to him. They had the same document."
The source, who declined to be identified because he was not authorised to speak to the media, said his stock was financed by Bank of China (601988.SS) and Industrial & Commercial Bank of China Ltd. (601398.SS).
"They called us to physically go down with them to start taking stock," he said. "It took us a couple of hours. But one thing is for sure, you can sense that the bankers are worried."
A full-blown scare at Qingdao and beyond would not only affect the supply chain and price of commodities.
Raising money using copper, iron ore or soybeans as collateral for relatively cheap loans is big business in China, a ready source of credit for investors who can then pour the funds into other ventures such as property.
It is also increasingly important in China as banks become stricter in extending credit. [ID:nL6N0ON35D]
Commodity finance deals in China were worth as much as $160 billion, about 31 percent of the country's total short-term foreign exchange loans, Goldman Sachs said in March.
The immediate fallout from the investigation could make such financing in China - already under scrutiny by authorities - even harder and costlier.
"Since the Qingdao case, we, as well as others in the market, have become a lot more cautious and are very selective on who we trade with," said the head of a metals unit at a Chinese state-owned trading firm.
"As for us, we are now only willing to work with big trading companies, those with which we've had a long-term working relationship or companies that have solid finances. This will be the strategy for many of us until we get more clarity."
Standard Chartered (STAN.L) said it was reviewing metals financing to a small number of companies in China. Three sources said the lender had suspended new metal financing to some customers in the country.
An executive in charge of commodity financing at an Australian bank said lenders would pause to take stock of how serious the problem in China was.
"If it's concentrated around one particular firm, we can probably quarantine it in that way and get ourselves back to a level of comfort relatively quickly," he said.
"If there's not already, it probably points to the fact that there needs to be a central registry of warehouse receipts."
Greater oversight of Chinese warehousing is needed to reduce the risk of future lapses, say China legal experts.
In one ongoing case, an operator allegedly allowed someone to enter his warehouse and replace peanut oil with water, steadily eroding the value of the collateral, according to a partner at a top law firm who is located in Hong Kong.
The switch came to light when the financing bank went to claim the collateral.
Copper prices on the LME hit one-month lows on Friday, amid concerns that owners of physical metal in China who have been spooked by events in Qingdao will look to sell, while others may shift their stocks to LME warehouses elsewhere. [MET/L]
"The countries where the LME is, the confidence level is much higher... and of course there is a (regulatory) structure in place," said one source at a warehousing company.
The LME, owned by Hong Kong Exchanges and Clearing (0388.HK), has warehouses in many countries, but it is not authorised to license warehouses in China and does not operate in Vietnam or Thailand or Indonesia, for example.
Hundreds of thousands of tonnes of copper that will ultimately be used in the car or construction industries sit in Chinese warehouses, notably in Shanghai, and much of it is believed to be tied up as collateral for lending.
The main problem for everyone in the business - be it commodity users, traders, banks or investors - is uncertainty.
"The (Qingdao) probe has sparked a lot of fear in the metals market," said a senior executive at a major metals brokerage.
"The unverified rumours about the size of the scam and the companies involved is causing people to panic."
Additional reporting by Melanie Burton in Sydney, Polly Yam in Hong Kong and Ruby Lian in Shanghai; Writing by Amran Abocar; Editing by Mike Collett-White and Alex Richardson