Fraud has been a prevalent issue in commodity trading and financing over the past few years, most recently in relation to cargoes of metals.
Nickel has been a common target when it comes to fraud, likely because of its high value and because it is currently accepted practice to pack briquettes of nickel in bags (unlike other high-value metals).
This in turn means that, particularly where shipped or stored in large quantities, it is less likely that those involved in the transport or storage of the cargo will notice anything untoward.
There have been a number of high-profile and widely reported nickel frauds recently, including one which lost Trafigura $577 million and one in which nickel purportedly owned by JP Morgan turned out to be bags of stones.
The latter only involved 0.14% of live nickel inventories on the LME, losing JP Morgan around $1.3 million, but the wider implications cannot be underestimated.
Thankfully there are ways to minimise the risk of falling victim to this kind of fraud, many of which are practical or operational, rather than legal in nature.
Whilst the continued reliance on documentation, which can often be easily manipulated or forged, means that there is no one-stop solution to protecting against fraud, a combination of different measures greatly increases the prospects of traders or financiers identifying a potential fraud at an early stage or avoiding it altogether.
1. Counterparty due diligence
Everything starts with counterparty due diligence. This should be viewed more than merely as a box-ticking exercise.
In a number of commodities frauds over the past few years, it has been reported that various traders and financiers stopped doing business with the perpetrators prior to the frauds being uncovered following due diligence checks. Others were less fortunate.
2. Transactional and documentary due diligence
Beyond counterparty due diligence, where a trader is looking to enter a trade, or a financier is looking to finance it, the underlying trade must make sense. As a bare minimum, there should be a written contract between the seller and the buyer which accords with the context of the trade.
We have seen a number of examples of (fraudulent) trade documents which are simply not consistent with market practice, e.g. very basic short-form confirmations in industries which typically rely on more sophisticated contracts or the incorporation of standard terms which relate to a completely different commodity and are unsuitable for use in the relevant trade.
Due diligence should also be done on the finer details of the trade and documentation:
- Do documents stating the whereabouts of the vessel match up with details available from other sources, such as vessel tracking software?
- How much detail does the documentation provide when describing the whereabouts of the goods?
- How closely and frequently are the goods being monitored, and by whom?
These points of detail are where a fraudulent scheme will often come unstuck, and the vast exposure that could result from overlooking them highlights the importance of robust legal and operational processes.
For financiers, there is an additional question to consider. Does the financing structure make sense from the customer’s perspective? It is normal for traders to seek to monetise inventories, but we have seen examples of goods (at least on paper) being kept in the same location for years at a time, without being moved or traded, whilst being used as alleged security for financing or as the subject of repo transactions.
In the context of the trade of that particular commodity, financiers should ask themselves whether it is realistic that goods would be left unmoved and unsold for that period of time and whether, for example, the nature (e.g. due to degradation) or quantity (e.g. for liquid cargoes, due to evaporation) of the goods may change over time.
3. Physical inspections
Whilst there are of course operational constraints and cost considerations, physical surveys of goods should be carried out wherever possible and, if the commodities are not simply in storage, at different points in the logistics chain.
Such verifications should be carried out independently by the relevant trader or financier (or someone appointed by them). As we have seen over the past few years, someone who is willing to commit fraud is no doubt willing to provide written confirmations to a trader or financier in an attempt to satisfy them that the goods are where they are meant to be, even if that is untrue.
Independent verification is therefore key.
4. Documentary due diligence
Both original and copy documents should be examined carefully for authenticity. When the commodities are in storage, warehouse receipts should be checked for watermarks, authenticity stickers and paper type.
Ideally, these checks should be carried out by representatives of the trader or financier to minimise the risk of foul play, or by the storage operator itself who will be familiar with the hallmarks of genuine documentation.
For example, in the recent case of ED&F Man Capital Markets Ltd v Come Harvest Holdings LTS & ORS , which concerned a large nickel fraud involving forged warehouse receipts, it was a representative of the storage company who first confirmed that the relevant warehouse receipts were not genuine.
5. Going digital
Digital documentation should be used wherever possible instead of paper documents. They are easier to collect and review, and harder to forge if proper security and authentication systems are in place.
Whilst this is an entire topic on its own, a number of jurisdictions, including England and Singapore, have moved towards recognition of electronic trade documents, such as bills of lading, as being equivalent to hard copy originals. A number of companies are offering blockchain solutions for trade documentation.
Singapore is introducing a Trade Finance Registry, which will enable banks to verify whether trade documents have already been used as security for other transactions. These are all welcome developments which help to limit the risks inherent in dealing with hard copy documentation.