Warehouse receipt system can help develop market mechanism

A well-developed process can provide a focus for improving the entire commodity chain.

The Warehouse Receipt System has a potentiality of a very high socio-economic payoff in India but it has not taken off due to various regulatory constraints.

The WDRA (Warehousing Development and Regulatory Authority) is authorised to regulate only the negotiable warehouse receipts of the commodity ecosystem.The authority has not been mandated nor does it have the jurisdiction to regulate the entire warehousing space, which remains a domain of various State Warehousing Acts. Even, non-negotiable warehouse receipts do not fall under the regulatory ambit of WDRA.

Since its constitution in 2010, the authority has not been able to convince the banks to use negotiable instruments for agricultural funding in any significant scale due to many structural defects in the WDR Act itself. The bankers privately confess that negotiability of the warehouse receipts in the current context of the Act does not give them adequate safety and assurance of repayment.

In case of default, the authority does not have the power to insulate the lender of safe return of the borrowed capital. The regulator has no direct control over the actions of the accredited warehouse, which may move stocks around without the knowledge of a regulator who is not on site.

The WDR Act has considered the structural robustness of the warehouse as fundamental to the accreditation process whereas in reality, the credibility of entities managing these warehouses has primacy on which the transactional business rests.

Therefore, it is important that warehouses should be adequately capitalised to carry on the activity. The adequacy of capitalisation and credibility of the warehousing entity has been totally ignored in the spirit of the Act.

Moreover, if a warehouse operator goes bankrupt, it may also be difficult for the bank to prevent priority being given to other creditors. To make the system successful, it requires careful analysis of the legal issues and a very rigorous set of guarantees and oversight mechanism.

Sometime back, the FMC (Forward Markets Commission) had directed the commodity exchanges to adhere to the standards of WDRA norms for accreditation of warehouses for exchange delivery. However, it must be noted that WDRA has no jurisdiction over any commodity exchange’s delivery mechanism. A registration with WDRA does not empower the authority to regulate the delivery on futures market.

The FMC is the supreme authority in case of anything that governs the delivery process along with the commodity exchange’s warehousing.

Warehouse receipt systems can play a central role in developing the framework of modern market institutions. A well-developed WRS can provide a focus for development of the entire commodity chain, providing incentives for a range of different parties including farmers, financiers, traders, processors and public sector buyers.

Difficulties stemming from the policy and institutional framework have made the introduction of WRS a difficult undertaking in India.

Published in The Business Line on 14th August, 2014

More time needed to clear confusion on warehouse receipts

Two terminologies — commodities demat and negotiable warehouse receipt — in the commodities market has created more confusion in the last seven years than in any participatory facilitation. 

The jargons have led the market to a state of confusion because these are perceived more as “insurance policies” underwritten by an exchange and the warehouseman (as applicable) for the users rather than instruments of facilitation. 

Brokers and investors are confused about “commodity demat” as they often draw a parallel to the seamless stock market functioning. In case of commodity demat, the mere act of recordkeeping in the electronic form has not conferred the qualifications of “security” on the commodity. The statute of “security” to the demat commodity has remained elusive under the Depository Act. Therefore, the funding of a demat commodity has conferred an inferior legal protection on the lender when compared to the demat funding of stocks. 

On the other hand, a warehouse receipt (WHR) is not negotiable under the common law. A WHR is an instrument issued by a warehouseman, reciting receipt of certain goods therein described and evidencing the contract between the parties along with the details of warehousing. What is being envisaged (however, not yet grasped) under the WDRA Act, 2007, is to confer on the document in a certain way the same sort of limited and peculiar negotiability which is possessed by a bill of lading. 

A WHR can only be an evidence to the title of the goods and not a promise to pay while a “negotiable instrument” means paper evidencing a debt ultimately reducible to money and not calling for the delivery of other property. 

The law regarding the document of title is trying to borrow the feature of negotiability from the law of negotiable instruments but it must always be remembered that the two classes of instruments — negotiable instruments on one hand and documents of title on the other — must in certain respects be different and be governed as they are today by entirely different bodies of law. 

The negotiable instrument is a promise to pay or an order to pay money while a document of title calls for delivery by a bailee (warehouseman) of certain particular goods. It is better to keep this thought in mind that a warehouse receipt is a document of title not a negotiable instrument and that there is a separate body of law governing each. 

If at all, WHR becomes negotiable, it will pass greater freedom from hand to hand chiefly by the reason of the fact that the transferee thereof does not need to notify the bailee (warehouseman) of his acquisition of title while a transferee of an assignable document of title (WHR) acquires no rights against the bailee except by giving notice.

By assigning negotiability on WHR will not provide the document with a status of “negotiable instrument” but can be referred as a “negotiable document of title”. It is going to take a while before the cloud of confusion is removed and we see a clear blue sky on the commodity horizon in India. 

People asking questions lost in confusion,

Well I tell them there’s no problem, Only solutions,

I’m just sitting here watching the wheels go round and round,

I really love to watch them roll, No longer riding on the merry-go-round, 

— John Lennon’s ‘Watching the Wheels’ 

Published in The Economic Times

Here’s another regulator in farmers’ name

India has a unique distinction of creating monoliths in the name of farmers yet the objective is to provide a better support function to established financial institutions.

As long as there is a public acknowledgement of this fact, there is nothing wrong in creating better systems. The tagging often in the name of the farmer is done to gain legitimacy.

The most recent initiative in this space was the creation of a regulator by the name of WDRA (Warehousing Development and Regulatory Authority). The WDRA Act 2007 came into operation on October 25, 2010, almost after three years since the bill was passed by Parliament. The regulator’s mandate is to put in place a negotiable instrument in the name of warehouse receipts (WHR). The main challenge shall be to create a foolproof network wherein this instrument is not used in the manner in which a large corporate house had done previously (issuance of multiple physical shares with the same number) or the fraudulent use of bank receipts by Harshad Mehta for leveraging in the stock market.

With the increasing “financialisation” of the commodity market, the laws and governance initiatives of the government seem to have remained etched in archaic classical economics of demand-supply and individualism. Institutionalised DEF (desire, expectation and fear) has now taken over the individual’s role in commodity markets. Price manipulation and leveraging are not anymore a businessman’s individual prerogative but are achieved through well-designed plans of policy manipulations and systemic loopholes. The new regulator is expected to bring a much-desired foresight in an environment of governance myopia.

While promoting instruments for pledge & collateralised struc ture in the commodity market one needs to take into considera tion the financial ramifications of these instruments. In the current legal structure, the ministry of consumer affairs may not be well-equipped to handle a financial instrument of this nature and the equipment are available elsewhere within the country. Without direct access to the ministry of finance and RBI, WDRA may not be constrained to access a regular financial information flow, talent and resource pool.

On the “farmers welfare account”, needless to mention, a majority of Indian farmers produce a lot size which is nonremunerative to be funded by financial institutions after considering the overall transaction cost and credit delivery cost. Therefore to make a case out of WHR that the instrument is going to help in preventing distress sale and shall give better access of credit to farmers is a more of a public relations exercise which is hard to be consumed even with a pinch of salt.

The chances are that in order to achieve economies of scale for credit delivery, we might see a new financial intermediation option and not a direct credit delivery. If an instrument of such great importance gets notified (if at all) in the Negotiable Instrument Act, then can we restrict it to only “agricultural produce” that will be the death sentence for the instrument (WHR) or will that be a solitary confinement? 

Published in The Economic Times