Impact of Chinese government's stricter supervision of finance-driven copper trading

Finance-driven copper trading takes one of two basic forms in China. The first is the mechanism by which traders conduct transactions so that they may obtain lower-cost financing from L/Cs. This has become more prevalent as the Chinese government has tightened credit, forcing companies to seek alternative sources of funding. The second is classic arbitrage on the price difference between SHFE and LME copper.

The Chinese government’s stricter stance over the finance-driven trade in copper is not expected to have an immediate impact on copper prices. SMM must conclude this, combined with stepped up supervision of off-balance sheet financing activities at the nation’s banks, will significantly restrict cash liquidity in the market. In cracking down on such behavior in the industry, the government has not only staved off further growth in such trading on false pretenses, but also sent a warning shot across other trading segments.

The mere existence of the finance-driven trade in copper, however, reflects not only price differentials between China’s domestic market and the global market, but also imperfections in the domestic lending system. So long as these two factors remain salient, some degree of finance-driven trade in copper is certain to persist.

Overall, the Chinese government stepping up supervision of the finance-driven trade in copper will not have a significant impact on the copper market in the near term. Stricter enforcement reduces the utility of L/Cs as a vehicle for raising cash capital, will complicate and slow the process across the board, reduce liquidity in the market, but crucially, will significantly raise the risk borne by those that rely on trade as an alternate source of financing.

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