What went wrong and how can this be avoided?
On 22nd April oil trading company Hing Leong Trading (HLT) filed for Judicial Management bankruptcy protection for itself and related companies in the Singapore courts. What at first was reported as being a potential $800 million loss is now looking like a much larger issue. It is a problem which started before the Covid 19 crisis and the ensuing turmoil in the oil market. Preliminary accounts are showing that there could be a hole of up to $3.3 billion and a possible debt recovery rate ofstood at 18 cents on the dollar .
OK Lim, the company’s founder is shouldering the blame, but how can it be that the company could have a deficit on this scale and only the owner was aware?
What Happened at Hin Leong Trading?
According to public news sources, HLT (Hing Leong Trading) had admitted to undisclosed losses of $800 million. These were sustained in futures market trading over several years, but were not reflected in its financial statements on the instruction of its founder OK Lim (HLT’s last audited financials dated 31st Oct 2019 reported a $78 million profit). It now transpires that its accumulated losses were considerably larger. Furthermore, with the drop in oil prices over the past few months, those losses have been compounded by a poor hedging policy resulting in further value destruction of the company.
*A hedge is a transaction where the derivative position on the futures market is intended to create an equal and opposite position to neutralise any exposure to market movements of the companies underlying business.
The scale of the losses will only be quantified once all inventory and receivables have been reconciled, but the signals are that there has been systematic fraud inside the company for an extended period time. What appears to have happened recently, is that the company was long physical oil products in a falling market. In order to disguise the losses and meet margin calls, documents were falsified to deceive some banks to finance new purchases. Stock and receivable amounts were apparently overstated. This ghost collateral was then pledged to banks who extended loans to HLT. It is alleged that in some cases HLT may have sold physical cargoes to customers that were still pledged to banks; effectively duplicating the collateral and the cash it was able to raise.
Should this have been noticed earlier and how?
Fraud by its nature is hard to detect – Afterall, the perpetrator is doing his best to cover his tracks. In the case of HLT, there should have been tell-tale signs to alert suspicion.
Some examples are:-
– Abnormal trading patterns – was it usual to have such large physical stocks and receivables for a local bunker trader?
– Large exposures to customers – do the customers normally buy on fixed price and what was the marked-to-market on these positions?
– The futures losses reached +US$800 million – were abnormal cash margins calls being made to brokers?
– Was there a regular independent stock reconciliation?
– Where the receivables validated by the customers?
Could anything have been done to prevent this?
HLT had various trade finance facilities from banks that allowed them to borrow money to finance their activities. These arrangements are very common in the commodities business and include;
– Trust receipts
– Assignment of account receivables
– Assignment of Letters of Credit
– Pledges of oil stocks against various title documents (Bills of Lading for cargo on vessel and Storage Receipts from oil storage in tanks)
Various controls can be put in place to try to prevent such an event happening in the future. But in most cases these controls will pick up the problem after the fact. Therefore, these measures can limit the damage, but it is very hard to prevent them from happening in the first place.
The key issue in the HLT case was the company’s ability to sell inventories that belonged to the banks. This may have involved issuing falsified contracts and inventory statements, trust receipts, fabricated Bills of Lading and fictitious invoices – Only as this story unravels will we discover what really happened and what the final damages are.
Trust is simply not enough, you also need to verify!
The fundamental problem stems from the commodities industry’s reliance upon paper-based systems; including contracts, trust receipts and title documents. These paper documents are all open to manipulation of one kind or another.
Of significant importance in this story is the element of trust. Many of the documents provided to banks are not validated by 3rd parties. In some cases, HLT’s banks took it on trust that the information provided was accurate.
At TradeCloud our goal was to build a communications platform specifically designed for the commodities industry – compliant, secure, trusted. Having contracts digitally recorded on the TradeCloud system was the starting point, as the contracts set out the rules of every deal (including the financing requirements). Once a customer has accepted the terms of a deal on TradeCloud, a contract is issued immediately. This means there is no doubt that the transaction took place as both buyer and seller have confirmed it and TradeCloud validates that. A bank could request (with the client’s permission) that TradeCloud confirm the existence of the contract. This eliminates the need for trust in the verification process.
We are now building our post-trade solution – TradeCloud Commodities Web – which will allow the 3rd party verification of B/Ls, warehouse receipts and invoices. All digitally signed and verified by an independent platform.
On TradeCloud we record;
1) The time and date that a contract is consummated
2) Digital signatures by buyer and seller
3) All of the agreed terms and conditions, including the GTC’s
On TradeCloud Commodities Web;
1) All parties involved in the post-trade operation can collaborate on the contract; including shipping companies, e-document providers, warehouse and storage companies and banks.
2) Permissioned for internal visibility to allow for oversight and four eyes principle.
3) Digital signatures and audit trail for every interaction.
The TradeCloud environment is a secure network on the Cloud, making it far less susceptible to fraud and cyber-crime. Our Commodities Web solution allows teams to collaborate whether they are at home, or in the office – meaning oversight is no longer a problem.
If you would like to learn more about how we are going about this, please feel to contact us via firstname.lastname@example.org
Author: Simon Collins – CEO of TradeCloud Services Pte Ltd.