How exchanges and banks can create new opportunities with warehouse receipts Lamon Rutten Senior Advisor, International Task Force on Commodity Risk Management in Developing Countries* Commodities: the present and the future Business Asia, Mumbai, February 2001 * Comments and suggestions are made on a personal basis only, and do not necessarily represent the opinions of the World Bank or UNCTAD

Overview The relevance of warehouse receipts How do warehouse receipts function? From closed to open systems Opportunities for exchanges Opportunities for banks What will the future bring? A possible integration scenario.

The relevance of warehouse receipts (1): the basics Credit risk on the borrowing company Risk on warehousing company Secured finance

The relevance of warehouse receipts (2): The asset conversion cycle Commodities “Paper” (e.g., warehouse receipts) Money To turn commodities into money, they need to pass through a financial transformation - they need to be replaced by “paper” which represents the commodities. Structured finance

How do warehouse receipts function? Warehouse receipts are documents issued by a warehouse keeper stating that goods certified on a receipt are held in his warehouse and at the disposal of the person named. By issuing them, he becomes legally liable for the goods stored. They can be negotiable or non-negotiable. In both cases, the warehouse receipts can be used as “substitute” for the actual commodities, including as collateral for a bank (to which they can be transferred, or pledged). If used as collateral for a loan, in case of a default, the bank can seize the commodities and sell them. If they are no longer in the warehouse, the warehouse keeper has to reimburse their value.

Open versus closed warehouse receipt systems WarehouseBorrower Bank deposit w.r. w.r., after individual negotiations CLOSED SYSTEM OPEN SYSTEM Borrower Open market Sale or pledging of w.r. Agree- ment

Exchanges can open up the warehouse receipt system Conditions: - standardization of quality descriptions into specific grades, and - standardization of the documentation used. Farmer/trader Exchange warehouse Commodity exchange 1. Deposits products 2. The warehouse receipt is (electronically) transferred to the exchange and auctioned off. 3. The highest bidder gets the products, and the farmer (trader) is paid

The initiative for an exchange ‘new style’ can come from exchanges…. or from warehousing companies. The example of the National Food Authority, the Philippines. The NFA network effectively links warehouses. The electronic network provides an “exchange” function, and the warehouses provide the “clearing” function. Surplus area Deficit area

Exchanges can upgrade the credit of the warehouse companies Small traders Large traders Banks Commodity exchange Warehouse company 3. Deposits products 1. Approves warehouse 2.Guarantees warehouse 4.Issues receipts 5.Lodges receipts with bank 6. Provides credit 7a.Sign sales contract 8a. Reimburses credit; in return, bank transfers receipts 9. Delivers receipt; warehouse makes delivery Clearing house 7b. Delivery through exchange

Opportunities for banks (1) Take over part of companies’ treasury management Many companies have a large part of their working capital tied up in stocks of goods - raw materials, inputs, spare parts, goods awaiting shipment. By having an independent collateral manager controlling these goods, the bank can effectively manage the related working capital needs, freeing up the company’s cash. In many cases, the bank may well be able to tap into hard currency finance for these goods.

Opportunities for banks (2) Give a mandate to “collateral managers”. Rather than waiting for a client to come, a bank can approve collateral managers (e.g., state warehousing companies, or field warehousing operators) up to a certain credit exposure. The bank can then announce that on a ‘first come, first served’ basis, those depositing commodities in warehouses controlled by such collateral managers can get credits for up to x percent of the value of the collateral at a rate of y. And the collateral managers have an incentive to “drum up” financing business for the bank.

Opportunities for banks (3) Look for possibilities for securitization. Institutional investors, in India and abroad, may well be interested in investing in bonds secured by a continuously renewed portfolio of warehouse receipts for commodities. This allows to bring agricultural lending off-balance sheet, and can tap into sources of low-cost, long-term financing.

Opportunities for banks (4): a new way to reach farmers Farmer/trader Approved warehouse Bank 1. Deposits products Master agreement 3. The farmer can withdraw cash, or get his smart card charged with electronic money, in special ATMs Automatic Teller Machines 2. Registers deposit on farmer’s/trader’s smart card Bank installs ATMs in mandis which are able to convert a volume of commodities deposited into an immediate value.

What will the future bring? INTEGRATION Money is a commodity, and commodities are money. Treasury bills and farmers’ (future) production become equivalent investment opportunities. Financialmarkets Commodityexchanges Warehouses Farmers & traders

The synergy of exchanges, warehouses and a modern information/communication system will make it possible to cross over into a new era for agriculture. Scenarios for the future exchanges warehouses communications Bridging the efficiency gap Being flexible and profitable Being slow and uncompetitive

Farmer/trader Exchange warehouse Commodity exchange 1. Deposits products 3. The farmer or trader can then sell his receipt to the highest bidder, or call for bids for a collateralized loan. Financiers Brokers 2. Receipt is electronically registered on name of farmer/trader 4. He can instruct a broker to hedge his commodities Traders Order execution Bids for physical commodities (spot/forward) Short-term placement of funds The exchange as central player

The Indian context Strategic action plan: Coulter & Ramachandran report for FMC, October 2000, 3 year action programme to create a proper system. Short-term possibilities: Create “islands of excellence” Major bottleneck: finding proper warehouses. Work with warehousing companies (CWC and state warehousing corporations) and collateral managers to identify warehouses that are properly managed. Get guarantees/insurance from warehousing company on professional indemnity and other risks. Who would take the lead? Exchanges or banks…..

THANK YOU. For papers and powerpoints on commodity risk management and structured finance: