Warehouse Receipts and Collateral

Management
Presentation to FICCI
New Delhi
17th July 2004
Agenda

z Current Status of
z Warehouse receipts
z Issues before Lenders
z Exchange physical settlements
z ‘Collateral Management’ concept
z Role and Functions of Collateral manager
z Risks and mitigants
 Efficient commodity markets
z Multiple buyers and multiple sellers
z Price discovery platform
z Price dissemination
z Transparent clearing and reliable settlement
z Spot and Futures markets
z Commodity based credit
z Commodity based tradable warrants

Essential elements for efficient post-harvest markets

Commodity based finance and warrants

z Policy environment
z Market information support
z Recognition of trader
z State as facilitator and regulator
z Stable and low interest rates
z No controls on stocking, movement and prices
z Legal framework
z Contractual rights of parties protected
z Facilitate trading in warehouse receipts

Enablers by and large in place

Commodity based finance and warrants

z Institutional framework
z Sound banking system
z Futures exchanges
z Price stability
z Network of warehouses
z Collateral Managers

The concern is on warehouses and collateral managers

 Warehouse receipt

z Document stating the ownership of commodity

z Specified quantity, quality and grade

z Warehouse location , storage fee etc.

z Can be sold or used to raise a loan

z Used for delivery against a derivative instrument

like futures contract

z Converts agricultural produce or other inventory to

a tradable warrant
 Legal status of warehouse receipt

z Conventionally accepted as a ‘document of title’

z Transferability contingent on terms and
conditions of issuer or by law
z Generally issued as transferable receipt
z Not a bearer instrument
z Need endorsement for transferring the rights
z Notice of endorsement need to be submitted to
warehouse
z Non-negotiable instrument

Limited usage in India; conventionally low status even

in comparison to B/L, AWB, R/R and L/R
Key issues in current warehouse receipt structure
z Warehouse receipt not a negotiable instrument in
India
z Transfer of title is possible with endorsement
z But title not free from any outstanding claims
z Weakens its status as a ‘security interest’
z Low credibility of the ‘warehouse' issuing the receipt
z No independent warehouse accreditation body
z Lack of
z Performance guarantees and reliable insurance cover
z Confidence in quantity and quality of underlying
commodity
Credibility of warehouse receipt needs to be enhanced
 Prerequisites for negotiability status

z Grading standards for commodities

z Market’s confidence in the warehouse operators
z Independent approval or accreditation
z Insurance and performance guarantee
z External supervision and monitoring
z Confidence in quality and quantity of stock
z Circulation of genuine receipts
z Easy transferability of commodity ownership
z Electronic holding of commodity balances

Collateral Manager as an independent and expert third party?

Key enablers for warehouse receipts
z Negotiability status of the warehouse receipt
z Collateral management services
z Grading, quality, quantity and weight controls of the
underlying physical commodity
z Process controls at the warehouse
z Insurance, legal and financial structures
z Protection of the marketable value of the collateral
z Secure electronic warehouse receipt system
z Mitigates the risk of physical tampering
z More checks enabled by the multiple parties
z Commodity information secure with depository
 Warehouse receipt system with Collateral
manager

Deposit commodities
Farmer/ Bank Finance
Farmer/Trader
Trader
Warehouse
Warehouse11
Warehouse
Deposit receipt
Coll
Collateral
ateralManager
Manager
commodities
Lender
Lender
22 33 44 55

Warehouse
receipt

Commodity
CommodityExchange
Exchange

Currently Rs 70 bn exposure by lenders as against annual agro

commodity size of Rs 11,000 bn
 Indian Collateral Management Spectrum

Clients Vendors
Warehouses

Lenders Transporters
Logistics players
Commodity C & F agents
exchanges
Grading , assaying
Farmers & Certifying firms State
Traders Management
Collateral Warehouse
Accrediting Agency
Processors Procurement
Depository Agency Agencies
Distributors

Exporters DPs and R & T agents Marketing

Agencies
Importers
Why banks do not lend against commodities
?
zPrice
risk - no mechanism for hedging
commodity price
zCredit risk - inadequate structures to transfer
risk from borrower to commodity
zOperational
risk – poor state of warehouse
management process and control on collateral
zInadequate and irregular MIS on stock
holdings

Curtailed lending against warehoused commodity- limited

credit flow to agriculture
How Lenders manage collateral?

z Bilateral arrangement

z No third party guarantees

z Ineffective stock verification

z Lack of control on funds and material flows

z No control over logistics

z No disposal plan
Risks and concerns for Lenders
z Lower credit rating of assets
z Larger capital adequacy
z Impaired assets – even where credit risk is not
the issue
z 90 day NPA norm makes the going tougher
z Curtailed credit flow for borrowers – especially
SME and Agro sectors
z Non fulfillment of sectoral lending
Present task of NCDEX in physical delivery
Specify/evolve commodity specific norms for
accrediting warehouses

Accredit the warehouses in each delivery center

Enter into agreement with diff. WH at different

delivery centers

Arrange quality certifiers and assayers to verify

the compliance of contract specifications at the
time of deposit

Notify the accreditation of the ware house formally.

Periodical Monitoring
Not core functions of Exchange
but essential to facilitate physical delivery
Warehouse accreditation norms

z Financial soundness

z Positive net worth of minimum Rs. 1 crore

z Sound management practices
z Technical parameters

z construction as per BIS / FCI stipulations

z Accessibility – free access by road and/or rail
z Least affected by natural calamities

z flood, landslide etc.

z Availability of requisite labour and other facilities

z weigh bridges, packing facilities etc.

NCDEX physical settlements
z The Exchange offers trade on 12 agricultural
commodities apart from gold and silver
z Around 10 new commodities under consideration
z Recent contracts with the feature of ‘seller’s
option’
z More physical deliveries expected
z multiple contracts at multiple centers
z More deliveries likely to boost Exchange volumes
z Robust and large scale arrangements required

Over the next 2-3 years, Exchange would need access to

around 500-600 warehouses
Drawbacks
z With expanding volumes, the Exchange is
increasingly required to :
z Ensure adequate accredited warehouse space
z No commitment charges paid
z Ensure availability of timely service of assaying and
quality certifying agencies
z Ensure coordination of the multiple logistics
providers
z Ensure tracking of commodity quality, quantity and
weight
z Undertake accreditation of the multiple agencies

Drawbacks lead to operational risks which

need to be mitigated
Concept of Collateral Management

z Collateral is an asset or a third-party commitment

accepted by the collateral taker to secure an
obligation of the collateral provider.
z “Collateral” has the same meaning as “security”
z Used to avoid confusion with stocks, shares, etc.
z Transaction intended to protect against
performance risk of counter party.
z Collateral Management involves managing the
collateral on behalf of the collateral taker
Global Scenario

z Large role in cross-border movement and trade

of commodities
z Specialize in servicing mortgage loan
requirements as well as financial collateral
z Valued high where the infrastructure is poor and
regulatory monitoring and compliance are
wanting
z Enable warehouse receipt financing by
mitigating operational risks and upgrading credit
rating
Proposed role of Collateral Manager in the
Indian context

z Ensures adequate accredited warehousing space

z Ensures quality and quantity of warehoused
goods
z Backs the same with guarantees and insurance
z Provides in-bound and outbound logistics
support
z Advisory and Inventory Management services
z Provides on-line and accurate reporting
z Facilitates disposal of collateral, when necessary
End-to-end collateral risk management solutions and
services for lenders, commodity exchanges and others
Functions and responsibilities of a
Collateral Manager
z Identification of potential risks and its mitigants
z Due diligence to set up a secure structure
z Accreditation / grading of warehouses
z Technical specifications & Financial evaluation
z Provision of warehousing space
z Producers/Traders/Processors, commodity
exchanges
z Empanelment of graders / certifiers
z Farm-gate to FOB handling services
z Facilitating structures for commodity lending
z Electronic systems for control and monitoring
z Arranging of 24/7 security
z Insurance tie-ups and adequate liability coverage
 Collateral manager- benefits
Clients
z Expands the credit portfolio based on
warehoused commodities / materials
Lenders z Mitigates operational risk in credit
Commodity decisions
exchanges
z Throws up early warning signals on the
Farmers banker’s screen
Traders z Losses can be controlled at an early
stage
Processors
z Enhances portfolio credit rating
Distributors z Enables bankers to focus on financials
Exporters and credit risk rather than logistics

Importers
Lender’s concerns addressed
z Price risk
z Hedge price risk on commodity exchanges
z Credit risk
z Collateral manager assist in effective credit risk
management and due diligence
z Operational/Performance risks
z Offloaded to the professional Collateral Manager
z Legal / litigation risks
z Reduced ; Collateral Manager ensures proper
documentation, adequate insurance cover etc.
 Structured Commodity Based Financing
z Structured form of financing with the objective of
transferring risk from entity to a commodity
z Soya loans; CPO loans
z Secured exposure on borrowing entity wherein
security is commodity

Borrower Borrower risk

Collateral
manager
Finance
Commodity
Lender can hedge his
price risk on NCDEX
Commodity risk
Lender

CBF will imply greater finance for the borrower and less risk to bank
Advantages of CBF + CM

z Raw material prices are locked thereby hedging

risks
z Leverage on raw material as the primary
collateral
z Attractive pricing through structuring
z Financing in convenient tranches
z Aligned with the stock build-up schedule
z Can be structured as off-balance sheet funding
 Collateral manager-benefits
Clients
z Increase in physical deliveries
z Wider participation by growers and
Lenders processors
Commodity z One stop service to mitigate operational
exchanges risks
Farmers z Spot trading and deliveries enabled

Traders
z Access to markets and better infrastructure
Processors z Reliance on market mechanism-reduced
dependence on government
Distributors
z Better price, staying power and lower
Exporters borrowing costs
Importers
z Finance readily available at lower cost
z Larger level of operations
 Collateral manager-benefits
Clients
z Improved supply chain
Lenders z Quality, quantity and weight checks
Commodity z Inventory / commodity based
exchanges
borrowing at better terms
Farmers
z Inbound and outbound logistics
Traders
support
Processors z Improved MIS - better inventory
management
Distributors
z Domestic and overseas logistics
Exporters
z Better coverage of insurable risks
Importers
Risks and mitigants for the Collateral
Manager
z Legal backing to accreditation
z Work with reputed rating agencies
z Negotiability of Warehouse receipts
z Law under drafting
z Electronic holding of balances
z Operational risk management in rating enhancement
structures
z Monitoring and inspection mechanism
z Pioneering concept- market acceptance
z Need for lenders and exchanges to expand business

New concept- hard selling needed

Credibility to be built up from the ground
National Collateral Management Services Limited
(NCMSL)
z The first national level Collateral Management
company to be set up in India
z Confirmed institutional promoters:
z NCDEX
z Audit Control & Expertise (ACE)
z ICICI Bank
z Canara Bank
z Corporation Bank
z Punjab National Bank
z Other interested institutions :
z Indian Farmers Fertilizer Co-operative Limited (IFFCO)
z HDFC Bank

Provide end to end collateral risk management solutions

Looking Ahead

z Current lending against commodities by Indian

commercial banks is just Rs 70 bn

z Expected to grow 5-7 fold over next 3 years

z Technology and risk mitigants – key enablers

z Emerging investment diversification

Next perceived boom after retail lending

Thank You