Going beyond traditional applications of warehouse receipt finance Lamon Rutten Coordinator, commodity marketing, risk management and finance United Nations Conference on Trade and Development Why the training shoes? Warehouse Receipts Financing - Making difficult deals more profitable? Day Robinson, Amsterdam, 9-10 July 2001

Overview Changing commodity trading practices impact on commodity financing Traditional “trilateral” warehouse receipt finance is still useful … but it is not necessarily good enough - possible ways to open it up New horizons

“Traditional” finance Current trend Local commodity producer Commodity trader Local bank Major bank 1. $$ 2. $$ 3. Contract, delivery and payment. Local commodity producer Commodity trader Local bank Major bank ??? 1. $$ 2. Contract, prepayment, delivery. Capital markets And even traders are increasingly being bypassed. Agricultural trade finance is changing. Among other things, development of vertical chains...

Traditional ‘trilateral’ warehouse receipt finance is still useful... WarehouseBorrower Bank deposit w.r. w.r., after individual negotiations agreement Although it is predominantly used as a good way to finance commodities in bonded warehouses, there are many possibilities to use traditional warehouse receipt finance in other settings. E.g., import finance (where it can be a valuable tool to continue providing finance after the disappearance of single-channel government entities), up-country finance (following the international traders, who increasingly buy upcountry rather than at the port of exports), financing South-South trade (from a warehouse in the exporting country to a warehouse in the importing country) and financing goods in cold storage (fish, meat…). Local warehouse Importer Bank 4. deposits goods 3. payment 2. agreement Local buyer Overseas supplier 1. agreement 5. payment 6. delivery

But they could be made more useful, with lower transaction costs and larger access, and providing more flexibility if the system were opened up - create warehouse receipt finance ”lines” or ”programmes”, rather than ”transactions”. In the most advance stage, this could mean that any borrower who deposits acceptable goods in an acceptable warehouse can then make various financiers compete on who will finance him…. WarehouseBorrower Bank deposit w.r. w.r., after individual negotiations CLOSED SYSTEM OPEN SYSTEM Borrower Open market Sale or pledging of w.r.

WAREHOUSE FINANCIAL INSTITUTION Trader/producer Loan W. Receipt Deposit Attornment agreement But there are many less far-reaching possibilities to open up warehouse receipt financing More than one financier (competition between financiers) More than one warehouse More than one borrower Semi-automatic credit if certain conditions are met “Empowering” of the warehouse Longer-term, revolving finance

How does a more open system of warehouse receipts look like? Example: enhancing farmers’ marketing reach (Philippines) Farmers National Food Authority warehouse Farmer deposits products NFA does not make an advance payment - instead, it acts as a physical broker Farmers give the order to the NFA to sell their products once a certain price is reached. NFA puts this provisional sales order on its (Internet) computer system (at a price in which transport costs from the rural warehouse to Metro Manila have been added to the farmers’ ask price). Processors and traders are directly connected to the system, and can continuously make bids for delivery ex-NFA warehouse in Manila. If a farmer’s ask price and a buyer’s bid price match, the NFA informs the farmer, and prepares delivery ex-Manila. At an opportune time, it then transfers the goods from the rural warehouse to its Manila warehouse. If after 6 months, the products have not been sold, farmers need to take them back, paying storage charges. While in stock, commodities can be easily financed.

An example of making a loan revolving - fish in West Africa The fisheries sector is one of the fastest expanding commodity sectors. In this case, a processor knew that if it could expand its supply, it had a ready market. The processor did not have its own fishing fleet, but relied on small fishermen. It found that in order to enable these to catch more fish, it should make it possible for the fishermen to go further offshore, for longer periods. This required fishermen to buy more diesel, for which they did not have the money... Lending cash to small, poor fishermen is risky. So instead, an international bank did not provide cash to the processor (for onlending), but diesel oil. This was put in a terminal controlled by a local bank. Individual fishermen had passbooks that allowed them to take diesel oil on credit. Reimbursement was through their sale of fish to the processor. This created a continuously revolving, easily administered credit scheme for the fishermen. The processor reimbursed through assigning a part of its proceeds from overseas fish sales.

How does a more open system of warehouse receipt finance look like? Example: selling the goods “with financing attached” Buyer B2B-exchange- approved warehouse Buyer makes successful bid This system has been implemented in an Asian exchange. A seller puts his products into a warehouse approved by the B2B exchange. The offer is put on the web, and a buyer successfully bids. He pays 20% of the value, and if he wishes, a bank that cooperates with the B2B exchange automatically finances the remaining 80% (so that the seller can be immediately paid). As long as the goods are in the warehouse, the finance remains in place. The bank relies on the creditworthiness of the B2B exchange and its clearinghouse - there is less work and less credit risk than when lending through individual loans to individual traders. Note that funds do not need to come from banks: institutional investors could also put their money in a scheme such as this.

A simple warehouse receipt finance scheme - open to various depositors. The“Pepper Storage and Ownership Certificate Scheme”, Pepper Marketing Board, Malaysia. This can act as a model to reach farmers - who are often willing to pay high interest rates. Farmer Trader Banks Warehouse 1. Deposits products 2.Issues receipts 3.Lodges receipts with bank 4. Provide credit 5.Signs sales contract 6. Reimburses credit; in return, bank transfers receipts 9. Delivers receipt; warehouse makes delivery Government (PMB) Note: the receipts are primarily used as marketing tools.

Provides smart card Farmer Automatic Teller Machine Banks Warehouse company Deposits commodities Charges the smart card Can withdraw money and eventually, get information with smart card Installation and management of automatic teller machines Input provider Agreements Farmer can buy inputs (or, for example, diesel) on credit How does a more open system of warehouse receipt finance look like? - an integrated financing system. Another way to reach farmers, this time without the need for a bank to put many local branch offices. The costs for setting up a system such as this are low - the most difficult is to find reliable warehouses.

Agricultural or agro-industrial firm Recognized warehouse 1. Deposit of goods 2. Issuance of warehouse warrants Broker 3. Transfer of warrant, with the agreement to buy it back after a certain period (repos) National Agricultural Exchange Investor/bank 4. Warrant is given in custody of Exchange 5. Open outcry bids on the interest rate for loans secured by the warrant 6. Credit Trading agricultural repos as credit instruments (as practiced in Colombia and Venezuela. While in Colombia, this scheme benefits from government guarantees on the warehousing risk, a similar scheme in which securities backed by live animals are traded on the exchange is successful without such government guarantees).

New horizons Securitization - Banks can develop the use of warehouse receipts as investment tools - portfolios of warehouse receipts can then be deposited with institutional investors. Advantages: Longer-term, revolving finance becomes possible (which reduces transaction costs) Cheaper funding sources (necessary to compete with new sources of commodity trade finance, e.g. special funds) Possibility to overcome the bottleneck of country/industry limits (which will become increasingly important). There are particularly good prospects for local securitizations: using the abundant stocks of cereals, sugar, fertilizers and the like which are meant for sale on the local market as underlying for local-currency securitizations. Given the large gap in deposit and credit rates in many countries, and the poor availability of short-term investment vehicles for corporate treasurers, such securitizations can provide great benefits to borrowers and buyers alike, and for the financiers that structure the deals. Given the growing rewards for risk capital, the role of monoliners is set to expand. Growing use of warehouses as an extension of the bank’s physical presence - with smart cards, the deposit of commodities in participating warehouses is like depositing money - giving farmers and others in principle access to a whole range of banking services (payment - smart card; finance - credit card; risk management brokerage).

Do banks have the wherewithal for this type of operations? Counter: due to inefficient lending practices in the past, most banks consider agricultural lending as very risky. Linked to this, appropriate skills are missing. In favour: 1. This is a safe type of agricultural lending. Instead of taking a risk on the farmer/trader, the bank takes a risk on a warehouse company/Government body/exchange. 2. This type of lending can be a spearpoint for other highly attractive forms of agricultural lending - e.g. for fertilizers, or supply schemes for supermarkets. 3. Refinancing is possible. The Federal Reserve (USA) as well as the Bank of England discount loans provided against “trade paper” (which includes warehouse receipts) on attractive conditions, including for non-US/UK stocks. 4. Banks will increasingly feel competitive pressures. The ability to “run faster” than the competitors thus becomes a condition for survival in the trade finance world.

For further information please contact: Lamon Rutten Coordinator, commodity marketing, risk management and finance United Nations Conference on Trade and Development 1211 Geneva 10, Switzerland Tel. (41 22) / 5755 / 5014 Fax (41 22) UNCTAD’s work in the area of commodity risk management and finance: - organizing international policy meetings on commodity risk management and finance. - reports, advice, training materials, training seminars and conferences on structured commodity finance, including warehouse receipt finance - reports, advice, training materials, and training seminars on commodity price risk management - advice to emerging commodity exchanges - advice to Governments on price risk management practices; use of modern financial instruments to support policy liberalization; and legal and regulatory structures affecting the use of risk management and structured finance markets.