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

Warehouse Receipt Recognition to Help Lenders & Borrowers

Pledge financing in commodity trade is not new to India. It had been in practice for the last three decades. However, it got a new lease of life due to emergence of collateral management companies in the middle of the last decade. The grassroots servicing was ensured through fee-based structures. The market meltdown in 2008-09 impacted increasing operational concerns in commodity financing and thereby raised the importance of monitoring commodities as security.

Physical availability of commodities assures not only that the advances are adequately collateralised but also the proceeds of the advances are properly utilised by the customer to purchase or process the commodities. Security of commodities can be ensured in two ways by the lenders: pledges or by way of ownership. Ownership or title to a commodity as a means of security is theoretically the best option for a lender. Yet, often banks prefer that their customers own the goods, given the responsibility and costs that ownership can sometimes involve. On the other hand, a pledge involves the delivery of possession of goods as security until payment. So, creation of the pledge involves two parts: the transfer of possession and the intention to pledge. In addition, the borrower must retain ownership of the goods. 

Two terminologies in the context need to be clarified: ‘constructive possession’ and ‘possessory pledge’. Constructive possession (often relevant with context to the collateral management) is a term to describe a situation where an individual has actual control over commodity without actually having physical control of the same assets. At law, a person with constructive possession stands in the same legal position as a person with actual possession. The other terminology ‘possessory pledge’ is much easier to deal with security given in the form of a possessory pledge as the identity of the collateral is incontestable and the intention of the borrower to pledge the collateral is clear, avoiding disputes as to ownership and competing claims. When the commodity is stored in a remote location or in many locations, third party control allows a borrower to utilise inventory collateral efficiently as a basis for advances. To assure that physical availability, the role of the collateral manager becomes all the more important. 

In certain cases, field warehousing (where instead of moving the goods to the warehouse; the warehouse is moved to the goods) the lender and the borrower enjoy the benefits of warehouse receipt financing. In doing so, the possessory pledge is converted to a relatively convenient and cost-effective form of security with a much higher degree of legal protection and practical control than is afforded by a registered charge or security interest. Warehouse receipts are often assumed to be a document of title similar to a bill of lading. Therefore, warehouse receipts are one way in which rights of constructive possession may be given to a pledgee. This is because Warehouse receipts are viewed as documents of title, the transfer of which can transfer ownership of the goods themselves. 

The laws relating to documents of title to goods held by recognised bailees and the rights of good faith purchasers and encumbrances holding such documents are maturing in India. In the next few years, WHR recognition will provide a powerful tool for lenders to lend and borrowers to maximise the collateral value of the commodities. 

Published in The Economic Times 

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

RBI Working Group on Warehouse Receipt & Commodity Futures

Report of the RBI Working Group on Warehouse Receipt & Commodity Futures Link