Friday, March 7, 2014
Chinese Copper Financing - should the financial world fear the copper rather than black swan ? China credit market roiled as default of Chaori Solar puts paid to perceived PBOC put ! Default worries hit not just credit markets resulting in several debt offerings being pulled but extends to commodities as well !
Dr Copper and Copper Swans......
Copper Collapses Most Since Dec 2011 On China Credit Fears
Submitted by Tyler Durden on 03/07/2014 10:08 -0500
We noted last night that Iron Ore futures prices were in free-fall as the vicious circle of China's commodity-collateral-backed shadow banking system unwind hits home amid fears of contagion from the Chaori Solar default. The first domestic Chinese corporate bond default has retail investors running scared as surprise spreads that the local government did not come to the rescue. The deleveraging is now spreading to copper prices (remember the massive cash-for-copper schemes of last year) as borrowers are forced to sell to meet cash calls which in turn drops copper prices, reducing collateral values and tightening credit conditions even more.This is the biggest copper price drop since Dec 2011...
More on Chaori and the fallout...
As Deutsche Bank notes,
On the topic of China, according to the WSJ the country’s first onshore corporate bond default has occurred earlier today in the form of Shanghai Chaori Solar Energy’s missed/incomplete RMB89.8m coupon payment. As we have written over the last couple of days, the bond is relatively small (RMB1bn or US$160m in face value) and the issuer is small (US$1.2bn in assets) but it’s an interesting case for a number of reasons.Firstly, it’s a bond where the majority of bondholders are retail investors (WSJ, citing company management) which widens the scope of the impact from the market’s typical institutional investor base. Weibo, China’s version of Twitter, is showing photos of retail investors at a local Shanghai government office protesting the authorities’ lack of action in assisting the issuer (21st Century Business Herald).Secondly, it should be highlighted that Shanghai Chaori avoided a default on its annual coupon payment last year due to the intervention of a local Shanghai government who persuaded banks to roll over loans. This time around, the policy appears to have changed with no last-minute assistance on the cards. Indeed, state-affiliated news agency Xinhua wrote in an opinion piece that a default would be the “the market playing its own decisive role”.Interesting, given that the Chinese solar energy market was heavily subsidised by the Chinese government in recent years. The Xinhua article also commented that Chaori was not going to be China’s “Bear Stearns moment”.In addition, domestic media are reporting that the company’s bankers and bond underwriters will not be helping the company make interest payments (21st Century Business Herald). Though this is a relatively small bond, there are potentially wider ramifications.Bloomberg reports that China’s renewable energy industry faces US$7.7bn in bond maturities this year, and already three domestic bond issuances have been postponed or cancelled in recent days according to Reuters. This is certainly a macro story to watch in 2014
Copper, as China pundits may know, is the key shadow interest rate arbitrage tool, through the use of financing deals that use commodities with high value-to-density ratios such as gold, copper, nickel, which in turn are used as collateral against which USD-denominated China-domestic Letters of Credit are pleged, in what can often result in a seemingly infinite rehypothecation loop (see explanation below) between related onshore and offshore entities, allowing loop participants to pick up virtually risk-free arbitrage (i.e., profits), which however boosts China's FX lending and leads to upward pressure on the CNY.
But what does it mean for the actual Copper Financing Deal? The below should explain it:
An example of a typical, simplified, CCFDIn this section we present an example of how a typical Chinese Copper Financing Deal (CCFD) works, and then discuss how the various parties involved are affected if the deals are forced to unwind. Exhibit 3 is a ‘simplified’ example of a CCFD, including specific reference to how the process places upward pressure on the RMB/USD. We believe this is the predominant structure of CCFDs, with other forms of Chinese copper financing deals much less profitable and likely only a small proportion of total deal volumes.A typical CCFD involves 4 parties and 4 steps:
- Party A – Typically an offshore trading house
- Party B – Typically an onshore trading house, consumers
- Party C – Typically offshore subsidiary of B
- Party D – Onshore or offshore banks registered onshore serving B as a clientStep 1) offshore trader A sells warrant of bonded copper (copper in China’s bonded warehouse that is exempted from VAT payment before customs declaration) or inbound copper (i.e. copper on ship in transit to bonded) to onshore party B at price X (i.e. B imports copper from A), and A is paid USD LC, issued by onshore bank D. The LC issuance is a key step that SAFE’s new policies target.Step 2) onshore entity B sells and re-exports the copper by sending the warrant documentation (not the physical copper which stays in bonded warehouse ‘offshore’) to the offshore subsidiary C (N.B. B owns C), and C pays B USD or CNH cash (CNH = offshore CNY). Using the cash from C, B gets bank D to convert the USD or CNH into onshore CNY, and trader B can then use CNY as it sees fit.The conversion of the USD or CNH into onshore CNY is another key step that SAFE’s new policies target. This conversion was previously allowed by SAFE because it was expected that the re-export process was a trade-related activity through China’s current account. Now that it has become apparent that CCFDs and other similar deals do not involve actual shipments of physical material, SAFE appears to be moving to halt them.Step 3) Offshore subsidiary C sells the warrant back to A (again, no move in physical copper which stays in bonded warehouse ‘offshore’), and A pays C USD or CNH cash with a price of X minus $10-20/t, i.e. a discount to the price sold by A to B in Step 1.Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration.Copper ownership and hedging: Through the whole process each tonne of copper involved in CCFDs is hedged by selling futures on LME futures curve (deals typically involve a long physical position and short futures position over the life of the CCFDs, unless the owner of the copper wants to speculate on the price).Though typically owned and hedged by Party A, the hedger can be Party A, B, C and D, depending on the ownership of the copper warrant.
As Goldman further explains, the importance of CCFD is "not trivial" - that is an understatement: with the implicit near-infinite rehypothecation in which the number of "circuits" in the deal is only a factor of "the amount of time it takes to clear the paperwork", there may be hundreds of billions, if not more, in leverage resulting from this shadow transaction that has been used in China for years. Now, that loop is about to end. The reality is nobody can predict what the impact will be, but whatever it is - i) it will extract tremendous leverage from the system and ii) it will have adverse impacts on both China's ability to absorb inflation and grow its economy.
First Default occurs , China credit beging to convulse ....
China Credit Markets Tumble Most In 3 Months As Default Spooks Lenders, Deals Pulled
Submitted by Tyler Durden on 03/06/2014 22:53 -0500
UPDATE: It's happened - China has suffered its first domestic corporate bond default as Chaori fails to meet interest payments on schedule and rather more surprisingly failed to receive a last-minute mysterious or otherwise bailout...
- *CITIC BANK WON'T HELP CHAORI MAKE INTEREST PAYMENT: 21ST HERALD
- *SHANGHAI CHAORI DEFAULTS ON BOND INTEREST PAYMENTS, WSJ SAYS
But hey don't sweat it, Moody's think it's great news...
- *MOODY'S: DEFAULT BY CHAORI SOLAR WOULD ADVANCE CHINA'S BOND MKT
Maybe tell the issuers that couldn't get their deals off today!!!
Of course what they mean is - maybe the market will finally start pricing in some real risk...
"Over the past few years, municipal governments and banks in China have stepped in to help distressed companies meet their bond payment obligations. These bailouts have led some investors to overlook the fundamental credit risks in bonds," says Ivan Chung, a Moody's Vice President and Senior Credit Officer...."A default would likely make investors recalibrate their risk-return consideration for onshore bonds. Credit risk would play a more important role in pricing, thereby making the bond market more efficient in the allocation of capital," adds Chung.
Chinese stocks are not happy
and there are a lot to come...
As Bank of America reports in an analysis by David Cui, the Trust defaults are about to get hot and heavy. To wit:
We believe that during April to July the market may see many trust products threatening to default, especially those related to coal mines. By our estimate, the first real default most likely could happen in May with a Sichuan lead/zinc trust product worth Rmb140mn. This is because the product is relatively small (so the government may use it as a test case), the underlying asset is not attractive (so little chance of 3rd parties taking it over) and we also have heard very little on parties involved trying to work things out. Whether this will trigger an avalanche of future trust defaults remains to be seen and this presents a key risk to the market in our opinion.
Ever since the specter of the first real domestic default on a Chinese corporate bond hovered over the markets, the Chinese credit markets have been leaking lower. The last 3 days have seen the biggest drop in Chinese credit markets in almost 4 months. That situation,wistfully occurring half way around the world while US equity markets press on to ever more exuberant (and ignorant) heights, meant at least 3 other Chinese firms pulled their bond issues today and,as Reuters reports, has "triggered widespread upheaval in the bond market." Banks are awash with liquidity (as indicated by low repo rates) but clearly unwilling to lend and external investors are now running scared.
The Chinese corporate bond market has suffered considerably in the last few days...
Even as repo rates have dropped (and CNY has strengthened) - repo rates at multi-month lows, CNY strengthening and stocks weak...
and SHIBOR at multi-month lows (suggesting plenty of liqudity at the banks but as we see below, a clear unwillingness to lend)...
And that has led to pulled issues...
The threat of China's first domestic bond default has prompted Suining Chuanzhong Economic Technology Development to delay a one billion yuan ($164 million) debt issue and two other companies have halted deals blaming market volatility....The run-up in corporate debt since 2008, and overcapacity in sectors such as steel, coal and solar energy, have threatened the solvency of many borrowers.Chuanzhong said late on Wednesday that the news that Chaori Solar was set to miss a coupon payment on Friday "triggered severe upheaval in the bond market", so it had delayed its bond deal.Taizhou Kouan Shipbuilding postponed a 300 million yuan issue of short-term commercial paper, while Xining Special Steel cancelled a 470 million yuan offering of medium-term notes, the companies said.The deals are relatively small, but the delays underline the risk that an unprecedented default will make it harder for other companies to access capital....Yields on corporate and enterprise bonds pushed higher after Chaori Solar's announcement. Five-year AA rated notes rose 8 basis points to 7.77 percent, the biggest increase since November 15, ChinaBond data showed....
This situation is being exacerbated as the lending is being cut to the indistries with the most slack - with the result (as we warned about in the past) that commodity-based collateral for all the shadow loans is getting hammered (through no real demand) and crushing the credit system (through haircuts and forced deleveraging as collateral values collapse)...
This is very negative for the Chinese economy which now more than ever is reliant on credit as its growth-driver... and the China credit-crisis indicator remains flashing red (2Y Swap - 2Y Bond spread)...
China Expands Defense Budget Over 12% To $132 Billion
Submitted by Tyler Durden on 03/06/2014 22:38 -0500
Submitted by Ankit Panda via The Diplomat,
The biggest Asia-Pacific defense story this week is China’s decision to increase its defense budget by 12.2 percent to about $132 billion for the next fiscal year. Notice that the figure is noticeably uncorrelated with China’s 7.7 percent actual growth rate (with a 7.5 percent target rate). The numbers are expected, of course, and send a clear signal across the region that China is taking its investments in military hardware seriously. Contrast the Chinese trend with the United States’ belt-tightening on defense spending. The United States and China are, of course, nowhere near to a convergence in defense spending. Our China editor Shannon Tiezzi takes a look at the similarities and differences between the two budgets.
Recently released defense budgets by China and the U.S. reveal different approaches but similar goals in Asia.
Beijing released its defense budget for 2014 today, as a draft budget was submitted to the National People’s Congress for review. Xinhua reported that the new budget called for a 12.2 percent increase, raising defense spending to 808.2 billion yuan ($132 billion). Outside of China, analysts and reporters viewed this increase with suspicion. “China’s Xi ramps up military spending in face of worried region,” a Reuters headline read. The article cited unease within Japan and Taiwan over a lack of transparency on how the money will be used.
Meanwhile, at the end of the February the Pentagon released its spending proposal, which called for cut-backs that would reduce the Army to between 440,000 and 450,000 troops (down from a peak of 570,000 in the post-9/11 period). News outlets across the country screamed variations of the New York Times’ headline: “Pentagon Plans to Shrink Army to Pre-World War II Level.”
The official Pentagon budget, released yesterday, called for $496 billion in spending, keeping the budget effectively static. Over the course of the five-year budget plan, however, the Pentagon actually seeks $115 billion more than was allocated for it by the 2011 Budget Control Act. The fiscal year 2015 budget in particular “seeks to repair the damage caused by the deep spending cuts imposed by sequestration,” according to an article on the Defense Department’s website.
The timing of Beijing and Washington’s defense budgets practically begs analysts to make comparisons—particularly since China and the U.S. seem locked in a long-term strategic battle for dominance in the Asia-Pacific region. The two defense budgets reinforce a narrative that suggests U.S. dominance is slipping in the face of a rising China: China raises its budget by double-digits while the U.S. undergoes painful cuts. As Zach wrote yesterday, spending cuts in the U.S. military particularly call into question America’s ability to finance the pivot to Asia.
The budgets also have different priorities for spending. Sun Huangtian, the deputy head of the general logistics department of the People’s Liberation Army, told Xinhua that the defense funds “will be spent mainly on modernizing the army’s weapons and equipment, improving living and working conditions for service personnel, and updating the army’s management system.” Chinese officials and academics cited in the article all agreed that an increase in spending was necessary due to external security challenges facing China, presumably including its territorial disputes in the East and South China Seas as well as a long-term strategic competition with the U.S.
Foreign Ministry Spokesman Qin Gang told the press that that China’s defense policy “is defensive in nature” and that spending increases were necessitated by China’s size and the geopolitical environment. “Some outside China hopes to see China stay as a boy scout and never grow up,” Qin said. “If that is the case, who will ensure our national security and how can the world peace be upheld? If that is the case, will China be tranquil, the region stable and the world peaceful?”
A spokesperson for the National People’s Congress was even more direct: “Based on our history and experience, we believe that peace can only be maintained by strength,” she told journalists.
Meanwhile, the U.S. budget focuses more on streamlining the armed forces as America transitions away from the war in Afghanistan. In a statement, Hagel said that the FY2015 budget and the new Quadrennial Defense Review explain “how we will adapt, reshape, and rebalance our military for the challenges and opportunities of the future.” Yet while Hagel and other DoD officials seem optimistic that the 2015 budget will allow them to do their jobs, they warned of disaster should another round of sequestration cuts take place in 2016.Assistant Secretary of Defense for Acquisition Katrina McFarland told a conference that further sequestration would result in a “hollow force,” as the DoD could not reduce troop numbers fast enough to be able to “preserve the integrity” of the armed forces. (Her alleged remarks that the pivot to Asia “can’t happen” may have been made in this context).
Hagel’s statement also warned that “continued sequestration requires dangerous reductions to readiness and modernization.” Such reductions, he said, “would put at risk America’s traditional role as a guarantor of global security.”
The defense budgets released by Beijing and Washington share few similarities, but they do have one thing in common: spokespeople claiming that their increased military spending is good for “global security” or “world peace.” On a global level, and more particularly on a regional one, both the U.S. and China are convinced that security can be achieved through an increased military presence.
China believes that the U.S. is pursuing a policy of containment, egging on its friends and allies in the region to challenge China over territorial disputes. Many top-level academics in China worry that U.S. support for Japan and the Philippines in particular has encouraged these two nations to directly challenge China, thus worsening the security environment. Accordingly, China is forced to build up its military to defend its claims, and also to discourage provocation by its neighbors.
The U.S., however, thinks recent actions by Japan and the Philippines are a natural response to what is viewed as increased Chinese aggression. Under this line of thinking, a more robust U.S. military presence in the region is taken as a positive contributor to regional security, because it would reassure countries that are increasingly nervous about China’s strength.
It’s a classic question of the chicken vs the egg: which came first, China’s aggression or U.S. containment?
Regardless of who is blamed for starting the cycle, it’s hard to deny that China and the U.S. are locked into a low-key (for now) arms race, where military spending by one side is used to justify defense budget increases by the other. But already, given the divergent trends in spending, some in the region are wondering how long the U.S. will be willing or able to match China’s investment in a regional military presence.Though the announced Chinese military budget is less than 27 percent of the U.S. budget, it’s safe to assume that close to 100 percent of China’s budget will be focused on upping Chinese readiness in the Asia-Pacific region. With a variety of global security concerns, the U.S. cannot make the same claim.
China’s J-20 stealth fighter has been the target of much peering and speculation by analysts in the West. The J-20’s design appear to be flawed particularly if it’s goal was stealth above all else. However, according to new reports, several problematic elements of the aircraft’s design have been modified, ostensibly to improve stealth performance. The J-20 isn’t expected to serve in the PLAAF anytime soon; the Pentagon estimates that it will enter service in 2018.As far as anyone knows, the J-20 appears to be designed specifically for indigenous use by the Chinese air force.China has not yet pitched it for export unlike the J-31.