Hot Money has long been a problem for China and can create major problems for commercial lenders and factoring companies financing trade as part of their portfolio.  In some instances, factoring invoices are often derived from an up stream trade transaction that is also financed by the factoring company.  Wu Ruilin, China’s Deputy of its State Administration of Foreign Exchange (commonly known as SAFE), has uncovered over $10 billion of fraudulent trade financing transaction especially with product flowing through 24 provinces including the Qingdao port (per Wall Street Journal Sept. 25th, 2014).   Companies or entities that are transferring money in or out of China through trade transactions without the permission from SAFE are considered to be making “Hot Money” transactions.  For example, the trade shipments involved in this type of “Hot Money” problem typically claim certain value on their shipping documents, but the actual value is not correct.  Therefore, the trade financing or funding connected to this trade transaction is transferring far too much money for the actual value on the documents.  This process allows money to be transferred across boarders without currency controls.  China blames much of the real estate appreciation in the last 10 years to be due to money from these areas.  Companies that are factoring invoices related to trade need to perform proper due diligence by having their own independent physical inspection at the port of origination to ensure the validity of the shipping documents.

A commercial lender or factoring company can take preventative measures to guard against Hot Money which is actually the process of laundering money in and out of China without the Chinese government’s approval.   A lender’s major tool to prevent the financing of Hot Money trades is to have their own set of due diligence practice for any type of trade financing.  First, a lender should have their own employees in China or boots on the ground.  By having your own staff to inspect the goods at the port or point of origination, one have a high certainty that the collateral on the shipping documents match the value being financed.  Also, basic KYC (aka Know Your Client) practices allow you to meet the requirements of the Patriot Act required by US law.  I would suggest taking this a step further and make sure you have done your due diligence on the factory or supplier as well.  Having knowledge that your factory and your client are both reputable entities and without major issue in the US and/or China adds a much greater level of security that your transaction will be successful.

Frequently in our due diligence practices, 1st PMF Bancorp (USA) and 1st PMF Capital (Hong Kong) use Hong Kong and Chinese government databases to review our foreign customers and their suppliers.  We also have our own underwriting team comprised of bankers and CPAs that visit the larger transactions and require financial info in order to even provide a proposal.  Having a good working knowledge of your local business and legal practices is key when financing in other countries. Hopefully, this info will add light to your future trade financing and invoice factoring deals.  I can be emailed if there are more detailed questions.