By Polly Yam and Fayen Wong HONG KONG/SHANGHAI (Reuters) - As global banks and trading houses fire off lawsuits over their estimated $900 million exposure to a suspected metal financing fraud in China, the tangled legal battle to recoup losses is set to drag on for years and hinder a swift recovery in metal trade.
HSBC (L:HSBA) is the latest bank to launch legal action since Chinese authorities started a probe into whether the firm at the center of the allegations, Decheng Mining, used fake warehouse receipts to obtain multiple loans.
Several banks had already ditched their commodity trading divisions due to low returns. The scandal, centered on the eastern port of Qingdao, means those remaining in the commodity financing business will have to consider their future, or at least bring in new controls on lending requirements.
It has also acted as a warning over murky business practices in China and highlighted the difficulties of navigating the Chinese legal system for foreign companies, some of which have since frozen new financing business.
"In the next six to twelve months, the impact would likely be reduced appetite for lending on metal collateral," said Daniel Kang, Asia head of basic materials equity research at JP Morgan. "Copper imports may come under pressure in the second half, partly related to smaller traders going bankrupt."
China's imports of refined copper, the most widely used metal in financing, fell 8 percent in June from a year earlier to hit a 13-month low as banks reduced lending for metals imports following the Qingdao probe, which was first reported at the start of that month. Using commodities as collateral to raise finance is common in China and not illegal, but duplicating receipts to repeatedly mortgage the full value of an asset is fraud and could leave more than one creditor holding claims to the same collateral.
MULTIPLE CLAIMANTS
With multiple claimants, cross-country jurisdictions, involvement of state-owned entities and a separate corruption probe into Chen Jihong, the chairman of Decheng's parent firm, the lawsuits stemming from the alleged fraud are unlikely to be wrapped up soon.
"The problem is that court judgments attained outside of China are not recognized on the mainland. Companies cannot simply take the judgments into China and have Chinese courts freeze assets," said William McGovern, a lawyer at Kobre & Kim who specializes in international commercial disputes.
Firms may also try to recoup losses via arbitration, as China recognizes international arbitration awards, but that process typically takes at least two to three years.
"The other question is, where are the assets?," said McGovern. "Obtaining an arbitration award against a fraudulent entity is only valuable if the defendant's assets can be located and seized to satisfy the judgment."In the Qingdao case, a problem for some Western banks trying to retrieve cash is that their contracts were signed with global warehousing firms acting as collateral managers, leaving them no direct way of claiming in Chinese courts.
To seek redress, some are teaming up with their collateral managers, which have local units holding contracts at the port.
"It's a strategic alliance," said a source at a global warehousing company. "The collateral managers have said to the banks: Let's join hands to get the real enemy."
Decheng and its parent could not be reached for comment, while attempts to contact Chen Jihong by his mobile phone were also unsuccessful. It was not clear if he has appointed lawyer to represent him.
POTENTIAL LOSSES
The full financial impact of the Qingdao case is unclear, but publicly traded banks and trading firms have been forced to disclose potential losses.
HSBC, Standard Chartered (L:STAN), Citi, Standard Bank (J:SBKJ), Mercuria Energy Trading SA and Citic Resources Holdings Ltd (HK:1205) have more than $880 million of exposure, according to company statements and reports.
In addition, Chinese media reported on June 18 that Chinese banks have a total exposure of about 16 billion yuan ($2.58 billion) on loans to Decheng Mining and its related companies.
Qingdao Port, whose listed Hong Kong unit faces a lawsuit brought by Citic Resources Holdings (HK:1205) claiming damages of $108 million, declined to comment on the state of the investigation.
Chen, chairman of Dezheng Resources, the parent company of Decheng Mining, had been detained by the Communist Party's anti-corruption body as part of an unrelated corruption probe linked to the state-controlled Western Mining Group.
He was only recently transferred to police custody in Qingdao for questioning, said a source who works at one of Chen's companies.
A native of China's Guangdong province, Chen has since taken Singapore citizenship.
For Standard Chartered and HSBC, which have filed various suits either in Hong Kong or Singapore against Chen and his main overseas financing vehicle, Zhong Jun Resources (S) PTE, a resolution could take years, lawyers said.
Standard Chartered and HSBC declined to comment.
Others hoping to lay claim on Dezheng's China assets will have to wait in line behind the Chinese banks, as they may be given the first claim on assets, lawyers said.
"You can never fully protect against somebody who is all set out to cheat," McGovern said.
"But you can protect yourself by doing thorough checks on both the individuals and the business and by using enforceable agreements, including having credible third-party guarantors who can assume the liability."
(Additional reporting by Melanie Burton in Sydney; Editing by Ed Davies and Alex Richardson)