Paperwork: top danger to commodities?

The minerals commodities industry may be worth trillions, but it has lost billions in less than a decade to fraud perpetrated by industry insiders due to roughly half of the world's mining companies and their warehousing networks still relying on paper documents.

This industrial blind spot has been made public by a series of news reports of fraud in metals trading, with the latest incidents having revealed devastating inadequacies in the records and storage systems of high-profile trading houses like the London Metal Exchange (LME).

LME is the world's benchmark futures market for base metals, with a warehousing network historically viewed as better protected against this type of criminal activity than recent events would suggest.

The LME introduced LMEpassport in 2021, collaborating with producers and standards bodies around the world to develop its digital ESG records platform. However, a chain is only as strong as its weakest link.

A security risk

In an increasingly digital world, the commodities market's dated reliance on paper-based documentation provides irresistible opportunities to play fast and loose with deceptive entries that cover for ineptitude or simply run under hugely inflated accounts.

Paper-based warehouse receipts and shipping documents can falsely represent anything from quantity and quality to ownership and location of goods. A single cargo can be collateralized for multiple loans or a trader might sell goods to which lenders already have a claim, without paying back the loan. Material can simply be stolen, but the threat of fraud perpetrated by industry insiders appears to be more common. Even something so simple as mislabeling cheap filler metals or paint rocks to pass a cursory inspection.

This year, copper producer Aurubis AG, which operates in several European nations and the United States, uncovered a large-scale fraud when some of its recycling suppliers manipulated details about the scrap metal they were delivering and worked with employees in the company's sampling department to cover it up with potential losses running into hundreds of millions of euros.

The LME discovered bags of stones instead of the nickel that underpinned a handful of contracts at a warehouse in Rotterdam.

Trafigura Group faced more than half a billion dollars in losses after cargoes it bought didn't contain the nickel they were supposed to. The year previous, several Chinese traders claimed that they were duped into providing credit of up to $74 million against fictitious quantities of aluminum, sending companies like commodities giant Glencore scrambling to audit their exposure.

Two of the biggest cases came in 2017, when banks and brokerages were duped on cargoes of nickel stored in Singapore, and in 2014, when a sprawling multibillion-dollar fraud was uncovered in China's Qingdao port.

A rush to digitize

For the industry to go digital, universally accepted standards are needed to replace paper-based approaches with global end-to-end traceability for commodities like minerals, metals, and gemstones.

"ESG data transparency and comparability are vital components in addressing industry level sustainability challenges," said Georgina Hallett, LME Chief Sustainability Officer. "We're delighted that already more than 50% of LME-listed brands are now sharing sustainability credentials on LMEpassport and we've recently added 12 new sets of certifications, metrics and standards against which producers are able to disclose. Galvanizing our industry to advance the global sustainability agenda is a core part of the LME's strategic focus and we look forward to further collaborating with our industry partners."

Yet the exchange is still reliant on private warehousing companies to weigh and inspect cargoes as they enter the system.

A host of startups are coming online across the globe, offering a range of services, including bidding and purchasing platforms, logistics management software, blockchain-based digital certification, and raw material and product passports, especially for electric vehicle batteries.

Alberta-based Daniola is also a rising star in the field and has created a full-service digital platform that connects buyers, sellers and vendors on a three-way marketplace. With backing from the Industrial Research Assistance Program (IRAP) technology arm of the Canadian government, the digital commerce exchange startup has developed a secure digital platform to establish increased security, efficiency and accountability specifically within the supply chain for mining.

Daniola, whose primary market is Africa but includes a growing number of Canadian and U.S. clients, emphasizes reducing the risk of conflict minerals entering the supply chain and facilitating responsible sourcing practices.

The company is a good template to follow, integrating several technologies that have been gaining traction – catered solutions for managing supply chains and logistics, digital wallets, geo-mapping, real-time analytics, chain of custody tracking and sourcing information. It also includes warehousing and transportation.

The first step is universal digitization of records, which, from a purely administrative standpoint, would reduce risk, cut costs, and save time. Following that, improved tracking and higher frequency and standards of inspection.

The LME's digital system has proved it can catch fraud in its warehousing network and, in time, will demonstrate whether it can also prevent it.

With all eyes on critical minerals and energy transition commodities, making a case for ESG tracking is important and timely. But, there is also an increased measure of security inherent in digitizing the supply chain alongside the search for greener resources.