Turning Bills Into Tools

Using warehousing receipts as negotiable instruments

For a developing economy like India, the establishment of credit flows is crucial to the success of the financial system. Warehouse receipts provide a marketing tool to the emerging private sector by reducing the role of government agencies in agricultural commercialisation and contributing to the creation of cash and forward markets.

by Radhika Rani G.

India is emerging as an important player in global trade. As consumption levels increase and commodity trading picks up pace, there is a dire need to meet the growing demand for an efficient supply chain capacity. Though the warehousing space in India is 1,800 million square feet, the share of organised warehousing is only 144 million square feet or just 8 per cent of the total.

At a juncture when Indian imports and exports gear up to meet the retail and utilisation demands the world over and when India requires a host of logistics hubs for its farm sector, it is time to evaluate the existing system. It is also time, as experts point out, for the industry to brace up for more capital flow in this key segment of supply chain management. “We need radical thinking to transform this sector and generate Rs 1,00,000 crore of investment as the warehousing sector requires such a capital,” exerts Capt Sanjeev Rishi, advisor to ICD Loni.

Also, as agri-logistics is yet to get its due in a farm-based economy such as India despite the government giving a fillip, it calls for more capital allocation from service providers. Private participation, says B B Pattanaik, CMD of Central Warehousing Corporation, is the need of the hour in building infrastructure and developing logistics hubs, more specifically storage capacities.

However, the farm sector is hardly aware of the changing dynamics in the commodities supply management. At best, they are familiar with godowns of the Food Corporation of India to stock their produce because Indian warehousing per se lacks quality, penetration and the much required spread. If more warehouses are needed as part of the penetration drive, more financing of warehouse receipts is required for transparency and buoyancy in trade. This initiative could well serve as a boon not just to farmers but also supply chain players, say experts.

Trade boon

Warehouse receipt, a seemingly familiar mechanism around the globe, simply implies bills used in futures markets to guarantee the quantity and quality of a particular commodity being stored within an approved facility. As per trade, they stand as a proof that settle expiring contracts and are often used when settling futures contracts of precious commodities. In short, they are a method of collateralising crops and lowering the risk to the lender, thereby lowering financing charges to the borrower.

In the light of the difficulties faced by farmers in obtaining finance for agriculture, warehouse receipt finance has emerged as an attractive alternative for farmers and processors in the developed world, say Nachiket Mor of ICICI Foundation and Dr Kshama Fernandes, researchers in the field. “Being negotiable instruments, these receipts can be traded, sold, swapped, used as collateral to support borrowing, or accepted for delivery against a derivative instrument such as a futures contract,” they explain.

Warehouse receipt financing, they say, has become a fairly mainstream method of financing in most industrialised countries and there is evidence that the overall efficiency of markets, particularly in the agribusiness sector, is greatly enhanced when producers and commercial entities can convert inventories of farm raw materials or finished products into a readily tradable device. It may be noted that warehouse receipts in the United States are deemed to enhance the presence of performance guarantees thereby improving the integrity of the warehouse system. They have been serving as negotiable instruments in managing and liquidating the huge grain inventories.

Commercial edge

As there are many corporates in the business of procuring agri-commodities on a large scale, the receipts can be of help to them, as the commodities stacked in the warehouses can be taken as collateral. By doing so, corporate companies can free themselves of blocking their capital during the time of procurement. The risk of loss of value of the collateral, say experts, can also be reduced by monitoring movement in the market value and using price risk management instruments.

As for farmers, the bills help them meet their immediate credit requirements. Also, the uncertainty of a reasonable remunerative price can be overcome as the rural producers can reap the advantage of their goods or a good crop stacked well in storage houses and also the benefits of higher price. The receipts can therefore lower the access barriers.

The system, say bankers, will help formalise trade transactions as a track record on farm activities can be put in place and genuine borrowers can be effectively screened without much delay. More importantly, the receipts enable banks to capitalise rural trade by reducing their monitoring costs and pepping up commercial lending to the farm sector.

And for companies trading in the futures market, a tripartite agreement reached by them with the bank and the farmer can help in buying commodities at a future price. In other words, the company can cover its risk by using commodity futures. Because conventionally, the corporates purchase raw materials upfront from farmers at the time of harvest and then place the stock in the warehouse. But following an understanding with the parties concerned, the bank can extend higher finance to the farmer against the warehouse receipt and eventually, the company’s payment is adjusted against the farmer’s loan and the surplus is credited to his savings account.

India infancy

However, warehouse receipts are yet to become a popular method of financing in India and the concern among trade pertains to a few institutional and structural shortcomings. Economists Richard Lacroix and Panos Varangis, who have been observing transition economies, point out three main inadequacies: 

• Lack of incentives for the development of a private storage industry owing to government intervention in agricultural markets – usually by setting support prices that take insufficient account of price variations over time or in different regions to allow for profitable storage;
• Lack of an appropriate legal, regulatory, and institutional environment to support a system of warehouse receipts; and
• Limited, if any, familiarity of the country’s commercial, including its banking, community with warehouse receipts.

These receipts are yet to be deemed as bankable assets by all financial institutions although three large public sector banks and one private sector bank have so far extended finance against them. And for the commodities market, identifying warehouses and creating infrastructure is a task in hand.

Although India has three electronic commodity exchanges – the National Commodities and Derivatives Exchange Ltd. (NCDEX), the Multi-Commodity Exchange Ltd. (MCX), Mumbai and the National Multi-Commodity Exchange Ltd. (NMCE), Ahmedabad, there is no specific platform for spot-trading thanks to the limited opportunity in disposing of physical commodities. Despite efforts being put by these exchanges in developing a physical infrastructure with the help of the Central Warehousing Corporation, a pronounced development of the commodities market can be ensured if the limitation of warehouses in a physical form can be overcome.

For instance, Shree Shubham Logistics has entered into a tie-up with the Union Bank of India for warehouse receipt financing solutions through which farmers can have access to credit without difficulty. According to the tie-up, Shubham will offer end-to-end solutions to the commodity stakeholders in agricultural and non-agricultural segment across India. The company will also be the service provider.

More recently, the State Bank of India extended its concessional interest loan offer to farmers till June 30 this year. As per the scheme, farmers can avail loans up to Rs 10 lakh against warehouse and cold storage receipts at a fixed interest rate of 8 per cent for the first 12 months in respect of loans sanctioned and disbursed till the end of June. In the second and third years, the interest will be 9 per cent and the rates will go back to floating from the fourth year, the bank says.

Similarly, HDFC Bank too launched a dual rate scheme, under which it offers a fixed rate of 8.25 per cent up to March 2011, then 9 per cent for the next one year and the prevailing floating rate for the remainder of the loan tenure.

Legal angle

If there are any drawbacks, they pertain to the legal framework in which the warehouse receipts system works. According to the Reserve Bank of India’s Working Group report, warehouse receipts, to work efficiently, require a recognised foundation in law ensuring that the ownership established by the receipts is not challenged. The receipts must therefore be functionally equivalent to stored commodities with well-defined rights, liabilities, and duties of each party, for example, a farmer, a bank, or a warehouseman.

The receipts, the report notes, must be freely transferable by delivery and endorsement and the receipt holder must be the first in line to receive the stored goods or their fungible equivalent on liquidation or default of the warehouse. A robust legal framework is a prerequisite to warehouse receipts being treated as secure collateral, the report adds.

Also essential is a warehouse infrastructure, grading and collateral management system that provides

guarantees on quality, quantity and storage of commodities, thus assuring that the quantities of goods stored match those specified by the warehouse receipt and also their quality is the same as stated on the receipt. This, says Nachiket Mor, will give farmers the confidence to store their produce and banks the comfort to accept warehouse receipts as secure collateral for financing agricultural inventories.

In addition, a special warehouse-receipt act could complete the legal foundation for an effective system of warehouse receipts, according to Richard Lacroix and Panos Varangis. “In order to work well, warehouse receipts need a recognised basis in law, so that the ownership established by the receipt is not challenged. Equally important are provisions for performance guarantees and the establishment of systems for warehouse inspection and crop-quality determination,” they add.

The need of the hour for farm-rich India is therefore to improve the efficiency of its agribusiness sector by helping producers and commercial entities to convert inventories into bankable devices. As reiterated, to sell, swap and serve should be the bottom line of these negotiable instruments.

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What is a Warehouse Receipt?

 

It is a receipt used in futures markets to guarantee the quantity and quality of a particular commodity being stored within an approved facility. Rather than delivering the actual commodity, warehouse receipts are used to settle expiring futures contracts, says Investopedia. Also referred to as a vault receipt, they are most often used when settling futures contracts that have precious metals as their underlying commodities.

Key suggestions from/for trade:

• Need for a guarantee of return and a recurring income or assured business to the warehouse
• Warehousing receipts need to be traded at the national level with guaranteed payments
• Banks should be able to finance against warehousing receipts
• Warehousing receipts should be bankable assets
• All buyers and sellers to be nominated a particular warehouse in the designated area for giving and taking delivery, to help in providing recurring business to warehouses
• Spot exchanges to hire warehouses on a monthly rental which can assure monthly income for the latter
• Land prices for warehouses to be subsidised with waiver on stamp duty thereby reducing capital costs
• Easy loans with subsidised interest rates for setting up warehouses.

 Preconditions for viability

The legal system must support warehouse receipts as secure collateral. The pertinent legislation must meet several conditions:

• Warehouse receipts must be functionally equivalent to stored commodities
• The rights, liabilities, and duties of each party to a warehouse receipt (a farmer, a bank, or a warehouseman) must be clearly defined
• Warehouse receipts must be freely transferable by delivery and endorsement
• The holder of a warehouse receipt must be first in line to receive the stored goods or their fungible equivalent on liquidation or default of the warehouse; and
• The prospective recipient of a warehouse receipt should be able to determine, before acceptance, if there is a competing claim on the collateral underlying the receipt.

Operational conditions must be conducive to the creation of a warehouse receipt system and include the following:

• reliable warehouse certification, guaranteeing basic physical and financial standards
• the existence of independent determination and verification of the quantity and the quality of stored commodities, based on a national grading system; and
• the availability of property and casualty insurance.

 

Article published in Maritime Gateway, May 2010.