Letters of credit (L/Cs) played an integral role in the financing strategy that appears to have caused the collapse of China's largest rubber trader.

Chongqing General Trading Chemical (CGTC) ceased operations after it failed to honour contracts with its local and foreign business partners because it misjudged its hedging strategy on rubber prices.

Unsettled markets

The collapse of the state-owned rubber trader that supplied over one-third of China's rubber has unsettled global rubber markets.

CTGC's financing strategy began with purchases of rubber from abroad on L/C terms and selling it on to local traders, many of whom were speculators.

Speculative strategy

The state-owned trader then speculated on anticipated falling rubber prices to hedge risks.

Once rubber imports arrived in China, CGTC partially paid its foreign suppliers with funds from its trader clients.

This worked well when rubber prices were fluctuating, creating liquidity for the state-owned company while both CGTC and its traders profited from accurate price forecasts.

Sluggish market

But a sustained period of flat prices dampened demand and made this financing operation unprofitable for CGTC because speculative traders lost interest in holding physical goods.

This meant that traders bought less and less from CGTC, thus choking the supply of funds the rubber trader had available to pay its suppliers.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.