While at the Ministry of Finance, Nairobi, for my internship last Summer (2010), I was assigned a rather interesting project--to research on operational framework for the Warehouse Receipt System (WRS) with a view of implementing it Kenya. Before then I had never heard of WRS and the concept was absolutely alien to me. The whole purpose of the program is to help farmers access credit in form of loans, thereby evading seasonal price volatility common in the country. How it works is that after harvest a farmer stores grains in public or private storage facilities--hence 'warehouse' in WRS--and and receives a receipt describing the grains stored. With the receipt as collateral, a farmer can then approach financial institutions for short term loans which would be paid back later when the farmer, in collaboration with the creditor, sells off the grains at a higher market price.The receipt allows farmers to also get into futures contracts.
On the whole, it was an instructive way of experiencing interaction between economics and agriculture, with a touch on legal and insurance issues. On the whole I learnt a lot. You may read on if you don't mind the length of the piece.
Warehouse Receipt System (WRS)
1. Brief
Executive Summary
Warehouse receipts have for sometime been
recognized as an important tool to provide the agricultural sector with
increased flexibility in marketing decisions and also mechanism to obtain
financing for farm operations. The idea behind Warehouse Receipt System (WRS)
is to have depositors store grains in secure and approved warehouses and use
Warehouse Receipts (WRs) as collateral for obtaining credit for immediate
financing needs. Warehouse receipts are therefore documents
issued by warehouse operators as evidence that specified commodities of stated
quantity and quality have been deposited at particular locations by named
depositors. The depositors may be producer, farmer group, trader, exporter,
processor or any individual of depositors.
Warehouse Receipt System (WRS) curtails a
number of challenges faced by smallholders in developing countries. These
challenges include cheating on measures hence high transaction costs; access to
finance at different levels in the market chain (producer, trader and processor);
seasonal variability of food/grains prices, lack of larger modern stores with
processing equipment, among others. The system facilitates trades and enhances
market efficiency. Through cost effective management of public food reserves,
WRS also reduces the need for the government to intervene in agricultural
markets and reduces the cost of such interventions if needed.
Key stakeholders in warehouse receipts
include farmers (individuals or cooperatives), warehouse operators, financial
institutions and traders. Other stakeholder could be input suppliers, millers
and processors, parastatals and food aid managers.
Warehouse Receipt System process
1) After
the producer has harvested his crop, he transports it to a certified
warehouse. The grain is checked to ensure that it meets the stipulated
quality standards.
2) If
the grains pass the quality inspected and the quantity is within the minimum
set by the Warehouse Operator (for example 100MT), they will be received by the
Warehouse Operator, who will then issue a Warehouse Receipt to the farmer.
3) The
farmer may present the Warehouse Receipt to a bank, which may offer him/her
short term financing, which will be a proportion of the market value of the
grain deposited in the warehouse.
4) This
enables the farmer to meet his basic financial obligations such as domestic
needs or preparing for the next planting season, as he waits for the price of
his grains to improve in the market. The Warehouse Receipt remains in the
custody of the bank.
5) When
the market prices improve, the farmer sells his grain and the buyer is
instructed to pay direct to the bank. The bank then deducts the loan and
interest from the proceeds and the Warehouse Operator also recovers any storage
charges.
6) The
farmer is then given the balance.
Warehouse Receipt System can be provided
under different warehousing arrangements:
·
In a private warehouse,
manufacturing and warehousing takes place under the same roof, and both
activities are controlled by the same company. The warehouse is just part of
the overall company operations, which may be manufacturing, wholesaling or
retailing. It is very risk to use commodities in private warehouses as
collateral for loans: other than spot checks by the bank, there is little to ensure
that goods are really present.
·
A field Warehouse is an
arrangement where a collateral management or credit support company takes over
the warehouse of depositor or public warehouse by leasing it or part of it for
a nominal fee, and becomes responsible for the control of the commodities to be
used as collateral.
·
A public warehouse is
normally a large storage area that serves many businesses, for example, in port
or major transit center. It is owned or rented for a long period and operated
by a warehouse operator, which stores commodities for the third parties for a
fee and acts as the commodities’ custodian. Public warehouse often issue
Warehouse Receipts that are acceptable as collaterals by banks.
Key elements of a Warehouse Receipt System
include:
·
An enabling legal and regulatory framework
·
A regulatory and supervisory agency
·
Licensed and supervised public warehouses
·
Insurance and financial performance guarantees
·
Financing banks with the use of warehouse receipts
Warehouse receipts are an integral part of
agricultural commodity exchanges as they allow trade to take place with
receipts rather the physical commodity.
2. Background
i)
Warehouse Receipting Worldwide
Warehouse receipt System has been in
existence in other parts of the world for the past 100 years. United States, for instance, enacted
The United States Warehouse Act in 1916.
Under the this act, the United States established a federal licensing
system for warehouses to provide for, among other things, financial security,
recordkeeping, protection and the operation items. Federal government inspects
and audits warehouses licensed under this act and they (warehouses) are
expected to conform to regulations designed to ensure the facility will
properly store and care for agricultural commodities delivered by depositors.
Government of India enacted a new legislation titled Warehousing (Development and
Regulation) Act 2007 for development and regulation of warehousing industry in
the country. Before the Act, Central Warehousing Corporation served as the
public warehousing agency. Banks, however, lacked confidence in the Warehouse
Receipts issued by the Central Housing Corporation out of the fear of not being
able to recover the loans in the event of misappropriation or mismanagement or
insolvency of the warehouses. The available legal options were time consuming
and inadequate. The new legislation that came into effect in September 2007
legally made Warehouse Receipts a prime tool of trade.
In
Indonesia, work on warehouse has been ongoing since mid-1990s. With the
help form International Finance Corporation (IFC), Indonesia has been able to
implement more comprehensive warehousing arrangements. In 2006, the parliament
approved warehouse receipt law, which provided a good legal foundation for a
more viable system. Implementation is under the auspices of the Ministry of
Trade through Commodity Exchange Regulatory Commission. In 2007, IFC initiated
commodity market evaluation, improvement of certification system and
introduction of a reliable performance guarantee mechanism. Currently, five
licensed public warehouses issue warehouse receipts for rice and maize. The
government is working on policies that seek to improve performance guarantees
mechanisms and strengthen inspection capacity.
Other countries in Eastern Europe and Central
Asia with advanced warehouse receipt system are Bulgaria, Kazakhstan, Hungary, Slovakia, Moldova and Lithuania.
These countries have had proper legal framework and several other structural
and institutional components of WRS in place for about ten years, and warehouse
receipts issued by public warehouses play a significant role in commodity-based
financing. They have been able to build initial consensus among key
stakeholders, institutionalize all the important elements of a warehouse
receipt system, and involve the financial sector in utilization of the system.
Consistent donor support has been instrumental.
ii)
Warehouses in Selected African Countries
I. South Africa
South Africa is considered to have the
continent’s most developed warehouse receipt system. Warehouses are managed by
the private sector. There is no specific warehouse act; rather, warehouse
receipts fall under contract law. There is no fidelity fund or any special
insurance arrangement for warehouses issuing receipts. Warehouse operators may
store their own grains and grains deposited by third parties, and can issues
warehouse receipts on both. Banks manage the risk associated with the system by
allocating specific credit limits to each issuer of warehouse receipts.
Delivery on the country’s future exchange is through warehouse receipts, as
long as they are issues by exchange-approved warehouses. The receipts are
managed mainly through an electronic system.
II. Zambia
WRS in Zambia is mostly private sector
driven. Certified operators either own or lease sheds or silos on commercial
terms and are free to charge storage rates.
Warehouse services were officially rolled out
in Zambia in 2001. The services are accessible to producers, processors and
traders. Initially the commodities to be listed were limited to maize, wheat
and soybeans but were later expanded to include other storable staples and
export crops.
Zambian Agricultural Commodity Agency Ltd
(ZACA) was established to certify and oversee warehouses. The certification was
designed to encourage investment in relatively small-scale rural warehousing
services, while not compromising the quality of service and trust in the
system.
For individuals/firms to be licensed to own
and/or provide warehouse services, they are required to meet the minimum
threshold capital requirement of US$50,000 and the warehouse should be able to
store up to 10 times their net worth. In addition, the applicant should meet
solvency criteria, provide a financial performance guarantee, show evidence of
professional competence and integrity and accept frequent unannounced
inspections.
Warehouses receipt the commodities that meet
prescribed weight and grading standards. Warehouse operators and their
frontline staff (samplers, graders and weighers) are trained and certified in
commodity quality and quantity assurance to facilitate enforcement of commodity
standards.
Zambia mostly uses electronic warehouse
receipt system (WRS).
Zambia is yet to develop a conclusive legal
framework to govern its warehouse receipting system.
III. Uganda
Private actors own warehouses in Uganda as
well. Farmers take their grains to warehouses licensed by Uganda Commodity
Exchange (UCE). At the warehouses, the grains are weighed, cleaned, graded,
dried, bagged and stored. Depositors get receipts showing tonnage and grade of
their grains. The warehouse charges a small fee to maintain the grains quality
till the grain is transferred to a third party or till the depositor withdraws
the grains.
Uganda created Uganda Commodity Exchange
(UCE) in 1998 but it was unable to gain traction with its trading floor.
However, the government, with help from the EU, launched a project to develop
the exchange floor in 2006. Uganda Commodity Exchange Act was passed in 2006
and Uganda Regulations Act followed in 2007. So far, Uganda has licensed three
warehouses and has been able to establish a grading system and implemented a
system of electronic Warehouse Receipts (eWRs).
Uganda launched its first Trade Floor for
sale and buying of warehouse receipted commodities in May, 2010. So far, UCE
works with a number of banks (House Finance Bank, Centenary Bank and
Opportunity Uganda) to finance Warehouse Receipts. That is, the farmers can
access bank loans from the financing banks upon placing Warehouse Receipts
issued to them.
IV. Tanzania
In Tanzania, warehouses are owned and
operated by private actors. Private firms and individuals interested in this
investment have to meet given conditions before getting certification from
Tanzania Warehouse Licensing Board.
Tanzania passed the Warehouse Receipt Act in
2005 and the Warehouse Regulations Act in 2006 and designated a Licensing
Board, the Tanzania Warehouse Licensing Board, in the Ministry of Industry,
Trade and Marketing. As of 2009, the Licensing Board has registered 20
warehouses (12 for cashew, 5 for coffee, 2 for cotton and 2 for paddy
rice).
iii) Warehouse
Receipt System In Kenya
Kenya is in the active process of
comprehensively embracing Warehouse Receipt System. As of April 2010, Kenya has
certified three warehouses—Lesiolo Grain Handlers in Nakuru (in 2008) and
Export Trading Company in Eldoret and Kitale. Twelve National Cereal and
Produce Board (NCPB) warehouses have been inspected with facilities in Eldoret
and Kitale receiving provisional certification.
Kenya is yet to develop a definite legal
framework to govern the system. As such, financing institutions have shied away
from accepting Warehouse Receipt as collaterals from farmers. However, NCPB,
under the auspices of the Ministry of Agriculture, is in the process of
introducing regulations that will delineate rights and obligations of
stakeholders in the system and also boost confidence in Warehouse Receipts
among financing banks. To this end, NCPB is proposing two bills—Warehouse
Receipting Bill and Commodity Exchange Bill—to be passed by the parliament
before the end of this financial year, 2010/2011.
In the meantime the Ministry of Agriculture
is inviting banks to embrace WRS and accept WRs as collaterals. So far,
EcoBank, Kenya Commercial Bank (KCB), Co-operative Bank and the National Bank
of Kenya have expressed their interest in participating in the system. Equity Bank
has been allowing farmers to borrow against their commodities since 2008.
3) The Way
Forward
From the initiatives already taking place in
the country, it can be concluded that Kenya is on the right course towards
fully introducing and operating WRS.
Firstly, it is worth noting that necessary
foundation for the system is already in place. For instance, NCPB has about 100
warehouses spread out in the country. These warehouses have a storage capacity
of over 1.8 million MT. Other institutions like KFA, KTDA, KPCU and KNTC have
substantial storage facilities and space. In addition, private companies like
Mbaraki Port Warehouse Kenya Limited, Kenya International Freight and
Warehousing Association also handle agricultural commodities for import and
export. Availability of storage infrastructure will help fast track the process
of rolling out WRS and ensure better accessibility of the services to farmers
most in need of such services.
Secondly, Kenya has a regulatory body—Eastern
Africa Grain Council (EAGC)— in place. EAGC has been in operation from 2006 and
has played a key role in certification of warehouses in Kenya and in the
general improvement in grain sector. Once WRS is officially in place, EAGC will
certify and subsequently inspect warehouse; standardize graining trading
contracts and settle arbitration disputes.
However, for the system to be successful,
more initiatives are key. These initiatives should be geared towards
strengthening regulatory mechanism, encouraging more private sector participation
and improving financial performance guarantee.
-Regulatory
Framework
A well-functioning mechanism for control and
oversight of the public warehouses is vital in guaranteeing integrity of the
system. While there are several approaches that provide appropriate regulatory
framework for the pubic warehouses, international experience shows that the
most common and accepted system for control is the creation of a Government Regulatory Agency. The
agency should be responsible for licensing, regulatory and inspection
procedures of the warehouse system.
The agency also becomes a good source of reliable information for banks
and obtains market information necessary for negotiation of credit conditions.
While Eastern Africa Grains Council (EAGC)
has so far been offering the necessary regulatory services for the certified
warehouses in Kenya, there is a need to modify its structure from that of a
private surveying company to that of a government regulatory agency that serves
not just private companies but also individuals and small holders in need of
its services. Modification of EAGC will attract a larger number of participants
and protect interests of all parties involved. It will also create an
environment for countrywide system implementation that goes beyond private
arrangements and demonstrates overall transparency and consistency of the
commodity market.
At the end of the day, a regulatory agency
should:
·
Organize and implement the licensing process
·
Maintain public registers of the public warehouses
·
Execute initial, periodical and special exams of the financial,
operational and technical condition of public warehouses as well as quality of
the stored grains
·
Collects orders for printing of warehouse receipts
·
Arbitrate in case of conflicts among warehouse operators,
depositors and financial institutions.
For
Kenya, the regulatory agency should also have mechanisms in place to ensure
that smallholders, who are the majority, benefit equally from the system as
large-scale producers. As such, the WRS should be designed so as to address
“relative capture problem”, where large operators own or rent entire or most of
the warehouses or silo and, as a consequence, lockout farmers or traders who
wish to deposit relatively small volumes of commodities. This will help a
majority of local farmers and traders who suffer from credit inaccessibility
and are more vulnerable to effects of seasonal price variability, problems that
WRS seeks to solve.
-Private sector
participation
While NCPD and other public institutions own
a substantial number of warehouses and silos in the country, it would be essential
for the government to create an environment that will pave the way for the
entry for private sector participation.
-Financial
Performance Guarantee
Financial Performance Guarantee satisfies
potential losses of the depositors in licensed warehouses in case of
bankruptcy, theft or mishandling of the commodity and they play a significant
role in the overall integrity of the system. They bolster the confidence of
banks in the whole system as well. For the system to be successful in Kenya, it
is important the country establishes a system to ensure financial performance
guarantee. Two approaches could be used in the establishments of the system:
i) Insurance
Bonds
It is important that warehouses purchase
necessary insurances to insure the warehouses from damages caused by agents of
natural like fire etc
ii) Indemnity
fund
An indemnity fund is needed to
cover the risk of potential fraud or negligent behavior by the licensed
warehouse. As the indemnity fund will only be funded over a period of time by
fees collected from the depositors, the use of public funds is needed to
provide a minimum initial capital.
International experience shows that different
countries approach financial performance guarantee system differently,
depending on local conditions and needs. In Ukraine the WRS began to operate
without any performance guarantees. Over the years however, the system was
challenged by several cases of default. Now the country is making serious
efforts to create an indemnity fund. In Bulgaria, the system is guaranteed by a
combination of bank letters of guarantees and indemnity fund. In the US,
performance guarantees are chosen depending on the federal or state
license—insurance bonds are widely used on the federal level while there are
fourteen indemnity funds at the state level.
4) Legal
Implication
For financing banks to have full confidence
in WRS, there is a need to develop a sound legal framework that expressly
delineates rights and obligations of the stakeholders in the system.
International experience reveals that there
are different approaches in the development of legislative frameworks. In some
cases, legislators build upon existing laws but usually the effort begins with
new legislation. In some cases like Ukraine and Indonesia legislation has been
developed on a broad base, encompassing various commodities and different
commercial practices.
Specialized WRS legislation, focusing on the
main commodities that will be used as collateral, is more appropriate because
it takes into account the specifics in the commodity related to storage and
marketing and better reflects these specifics into the legal text.
It is worth noting here that, NCPB, under the
auspices of the Ministry of Agriculture, is in the process of delineating a
legal framework for WRS. It is expected that two acts of parliament will be
passed in this financial year, 2010/11, to address running of WRS and Commodity
Exchange Markets.
6) Conclusion
Establishing a warehouse receipting system in
Kenya is long overdue. With proper structures and sound regulatory framework in
place, WRS will not only liquidate agricultural commodities in the country, it
will also provide much needed state-of-the-art storage facilities to the
farmers, especially smallholders who cannot afford such facilities. WRS will
also curtail information asymmetry between buyers and sellers of agricultural
commodities and as such trim down transaction costs incurred in the process.
WRS will pave way for trading of
agricultural commodities through the Commodity Exchange, resulting in better
value and price realization to producers.
While
the necessary structures are already in place, in terms of storage facilities
like silos and warehouses under NCPB, there is a need for the country to
fast-track sound legal modifications necessary to outline the rights and
responsibilities of all players in the system and to bolster financing banks’
confidence in WRs. There is also a need for the regulatory agency, in this case
a modified EAGC, to synchronize operational framework for all certified
warehouses across the country.
