When prices fall, frauds arise. This time, after the price of precious metals have fallen significantly, the deception at the Hong Kong Mercantile Exchange became evident. The fraud consisted in overstating the Exchange's cash balance, which was being used by Chinese insiders to speculate in the price of gold and silver. When such bets didn't go their way, the amount by which the cash balance was being overstated became too wide to keep concealed any longer, as its cash funds were too low to keep the Exchange operating. And thus, the money was "vaporised," à la Corzine.
The insider fraudsters speculated on a daily basis with the Exchange's cash but closed their positions at the end of the day. That's the reason why the daily volume increased every month whilst the open interest decreased every month. In 2011, the average daily volume was 4,229 for the 1 kilo gold futures and its year-end open interest was 772. In 2012, the average daily volume was 5,042, but its year-end open interest was just 112.
As most Chinese frauds, this was a multi-year operation. The reason these frauds take so long to be uncovered is not because of fraudsters' ingenuity, but because of victims' gullibility, who keep funding the fraudsters' operation. Among those involved in this fraud is its chairman, Barry CHEUNG Chun-yuen, who will never be charged of any wrongdoing, as he is an associate of LEUNG Chun-ying, Hong Kong's head of government. Thanksfully, the funds of both hedgers and speculators were not stolen, but this was not because they didn't want to steal them, but because they couldn't: the Exchange didn't have a clearing house of its own since LCH.Clearnet was clearing trades for them.
Unsurprisingly, this is not the first time a Chinese futures exchange goes bankrupt due to fraud. In 1987, the Hong Kong Futures Exchange (HKFE) closed its doors due to a margin fraud perpetrated by Robert NG Chee Siong, the chairman of Sino Group. As it happened, the perpetrator was rewarded with HKD 500 million, which were raised from taxpayers by the government of Hong Kong to rescue the Exchange. Simultaneously, the Hong Kong Stock Exchange (SEHK) was also rescued by the government, but it required a much larger amount: HKD 4 billion.
By the way, it is a matter of time before the London Metal Exchange suffers a premeditated "vaporisation" of its clearing house funds at the hands of its new Chinese bosses: the Hong Kong Exchanges and Clearing, which also owns the HKFE and the SEHK. But the likelihood of fraud at futures exchanges managed by Chinese presents an opportunity for American and European futures exchanges to offer competing products such as futures on the MSCI China index and the like. Offer them, and they will come.