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Commodities Fraud and its Effect on Finance

The more recent advent of fraud in commodities-based trade finance is creating a culture of greater caution and even pushing financial institutions out of the sector. This is occurring in the inherent stress-inducing backdrop of the global pandemic. Here, this article looks at the current situation and the reasons for its emergence….


Five Things



According to the Global Trade Review (GTR), there were five critical topics that influenced trade finance through 2021. The collapse and ongoing saga of Greensill Capital was one, which entered a liquidity crisis when Credit Suisse suspended two of its investment funds.


It ultimately emerged that Greensill had been engaging in a practice dubbed ‘future receivables’ whereby finance was made possible through anticipated invoices rather than actual or approved ones. The digitalization of trade and its financing has seen a huge boon. The main reason for it has been the pandemic: with digitization has come automation which became acutely useful when lockdown measures and the disease itself prevented people from going to their place of work.


Another pandemic-induced issue that has impacted trade and its financing has been supplying chain disruption. As production and transit of materials tailed off during the crisis, when vaccines were rolled out and lockdowns were lifted, supply rebounded and the infrastructure became inundated.


This is a problem set to continue into 2022. ESG in trade and export finance was pushed to the top of the agenda as the COP26 climate conference arrived and the urgency with which society must make amends for its environmental negligence dominated the news. As the consequences of climate change grow and governments are forced to act and react, ESG is set to loom larger and larger on the radar of trade and its financing.


The fifth topic discussed by GTR is that of fraud in commodity trade finance. Known more simply as commodities fraud, it is regarded as the illegal attempt to acquire money in connection with the future promise or contract of the delivery of assets.


Perhaps predictably, these assets are never delivered and tend to be commodities traded on established exchanges. The largest in the world – according to Investopedia is the NYMEX.


Essentially, commodities fraud involves exchange members who operate with no economic intent other than to gain profit by providing false or misleading information, or stealing the money of customers.


Imperiled


As pointed out by Lovell for The Hedge Fund Journal, in 2014 $8.8 trillion of commodities were distributed worldwide and 80-90% of it involved financing for credit or liability mitigation. A basic model for commodities trade finance can be seen in figure 1 with there being four primary ways in which commodity-based trade finance occurs. Effectively, there are five stages of the trading process,

Figure 1: A basic model for commodities trade and trade finance (The Hedge Fund Journal).

and possibilities for trade finance perch neatly between each stage (with the added complexity of some deals taken into consideration). Given how deals can be convoluted and layered throughout a supply chain, the potential too for bad actors to enter the space is obvious.




Around the beginning of June 2021, Jean-Francois Lambert told the International Grain Council’s annual conference that fraud in commodities trade finance had imperiled the sector more greatly than that of the 2008 financial crisis (as reported by Reuters via Nasdaq.com). He stated how the situation is worse because it was not a case of banks scaling back their operations, but rather that they were withdrawing from the space entirely. One such example was the withdrawal of the Dutch creditor ABN AMRO MV ABNd.AS in August of 2020. It had been stated that fraud in centers such as Dubai, Singapore, and Rotterdam, had made achieving profitability a far more difficult prospect. Not soon after, BNP Paribas announced the closure of its commodities trade finance arm after the pandemic had revealed a number of defaults and frauds.


The Island City-State


In Singapore in particular, the case of Envy Group is a poignant one due to an alleged billion-dollar nickel trading scam. According to Bloomberg, Ng Yu Zhi – the owner of the Envy group of companies – swindled around $352 million out of investors.


The companies are now being overseen by interim judicial managers at KPMG who have suggested that Envy should be liquidated. Ng is looking at 32 charges and is accused of misappropriating at least $201 million. Ng himself is thought to have spent about $2 million per month in order to fund his lavish lifestyle whereby he employed the services of a butler and a chauffeur, dined inexpensive restaurants and stayed at inexpensive hotels, and provided generous monetary gifts to his associates.


The alleged fraud itself is having far-reaching consequences throughout one of Asia’s wealthiest nations because the list of victims is growing and has included some high-profile individuals from Singapore’s assets management and legal sectors. Staying with the island city-state, Agritrade International and Hin Leong – two Singapore-based traders – collapsed one after the other in early 2020.


Since that time (and pointed out by GTR), criminal charges have been filed against senior executives and creditors have been scrambling to try and recover at least some of the lost funds. It is suspected that liabilities to various financial entities may total as much as $5 billion.


Other Singaporean businesses where issues have arisen are ZenRock, HonTop Energy, and Sugih Energy, where in some cases investigations and litigation are still ongoing.


Through 2020, further issues emerged around smaller entities such as GP Global and Phoenix Commodities both in the United Arab Emirates. More broadly, financial entities have become reluctant to dabble in the commodities space and if they haven’t reduced their activities there in some way, they’ve decided to leave the arena altogether.


All in the name of prevention. In fact, traders have coined the term ‘flight to quality’ in some corners where businesses have restricted their dealings to small numbers of larger firms thus reducing their exposure to the sector. However, there are potential lessons to be learned from such frauds and defaults.


Some businesses involved in the industry have been pushing for heightened due diligence measures, improved information sharing, and more comprehensive risk assessments. In October 2021, a best practice guide was published by the Swiss Trading and Shipping Association where 10 commodity financiers had spent a year collaborating on how to move forward.


In Singapore itself, the banking association has teamed up with Enterprise Singapore to produce a code of conduct with the aim of increasing transparency in the industry.


Other entities are also at work to tighten up the sector, especially technologically. Unsurprisingly, blockchain innovation might be to the rescue again. Standard Chartered and DBS Bank have collaborated on a project to construct a blockchain-based registry of trade finance transactions.


This would ensure that multiple financing applications couldn’t be raised against a single cargo say, without disclosing confidential commercial particulars. An unexpected side effect of all of this is the impact on Small or Medium Enterprises (SMEs).


Generally speaking, financing for commodities trading has become concentrated at the larger end of the market. Smaller traders and SMEs have reported some reticence on the part of lenders to extend credit since financiers are wary of finding themselves embroiled in another fraud or scandal. For the time being, this trend appears set to continue…




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