The 4th African Rural and Agricultural Credit Association [AFRACA], Agribanks Forum. (May 6, 2010)

1. The 4th African Rural and Agricultural Credit Association [AFRACA], Agribanks Forum. (May 6, 2010) Enhancing Rural Incomes through Agricultural Commodity Markets and Warehouse Receipts. By Yusuf Abdurrahim MD/CEO Abuja Securities & Commodity Exchange

2. COMMODITY PRODUCTION & MARKETING Commodity Production constitute the largest source of revenue and employment for the population of Africa with 65% of their total exports originating from the Commodity Sector. Africa’s Commodity dependance is characterized by low; low productivity, quality, value added and competitiveness. Hinders the achievement of the required level of economic growth and poverty alleviation. Rudimentary technology and policies made Africa loose its competitive advantage to Asia and Latin America in the production of some of our traditional products. Insecure land tenure systems, difficulties in achieving economies of scale.

3. COMMODITY PRODUCTION & MARKETING • Share of Africa in international trade and the prices in real terms have continued to decline. • We need to; establish and strengthen institutional framework for the African Commodity Sector to create strong commodity value chain. • Develop suitable delivery Models for managing commodity risks at the farm and National levels. • So as to reduce the vulnerability of farmers to Income declines and price volatility, to eliminate poverty, achieve sustainable development and attain targets of the MDGs. • Take necessary Measures to diversify through a dynamic Public-Private Partnership.

4. COMMODITY QUALITY & ACCESS TO CREDIT Introduce appropriate measues to; • Assist small producers to enter into new spheres of activity and high cost producers to overcome “exit barriers”. • Address Market access conditions and supply capacity needs • Meet exigencies of Markets in terms of quality, traceability, standards, volumes and continuity of supplies. • Upgrade infrastructure in storage facilities, quality testing laboratories and transport in order to improve competitiveness. • Access to Credit is probably the single largest obstacle to diversification and commodity-based development. • Lack of bankable collateral and high interest rates are Major difficulties.

5. INTRA - AFRICAN TRADE Evolve a simple system that will ; - Reduce financing costs and increase availability of funds using the commodity itself as collateral (Warehouse Receipts). - Foster Greater investment in Commodity development - Improve transportation and communication infrastructure. • Greater harmonization of trade facilitating measures to raise Intra-African Commodity trade to a more significant level. • Establishment of Regional Commodity Exchanges to provide trading platforms on Commodities that would facilitate price discovery, transparency and sanctity of contracts.

6. Warehouse receipts as negotiable instruments backed by the underlying commodities, are an integral part of the marketing and financial systems of most industrialized countries. The overall efficiency of markets in the agribusiness sector, will be greatly enhanced if producers and commercial entities can convert inventories into readily tradable device. Warehouse receipts can be traded, sold, swapped, used as collateral to support borrowing, or accepted for delivery against a derivative instrument such as a futures contract. WAREHOUSE RECEIPTS

7. WHR – INFRASTRUCTURAL DEFICIENCIES The use of warehouse receipts is limited in many developing countries due to institutional and structural deficiencies such as; • lack of incentives for the development of a private storage industry owing to government intervention in agricultural markets. • lack of an appropriate legal, regulatory, and institutional environment to support a system of WHR and; • limited, familiarity of the country’s commercial, including its banking community, with warehouse receipts.

8. WAREHOUSE RECEIPTS Warehouse receipts provide farmers with an instrument that will allow them to extend the sales period of their produce well beyond the harvesting season. • The farmer does not need to sell the product immediately after harvest when prices are low in order to ease cash constraints. • Farmers deliver their product to an accredited warehouse, and obtain a warehouse receipt. • Use the WHR as collateral for short-term borrowing to obtain working capital. • The Farmer sells the product, pays back the loan and WH charges and makes an appreciable profit.

9. WAREHOUSE RECEIPTS • This option is attractive only if the farmer expects that seasonal price increases will make it worthwhile to store the product and sell it later. • Unfortunately, governmental price supports to decrease price volatility and “stabilise markets” are often structured in such a way that these expectations are not met. • Moreover, real interest rates are often very high in developing countries, making borrowing against inventories infeasible • Also, high real interest rates are often linked to perceived risks, particularly when it concerns agriculture, secure warehouse receipts may reduce risk and lead to lower lending rates.

10. WAREHOUSE RECEIPTS • Correctly structured warehouse receipts provide secure collateral for banks by assuring holders of the existence and condition of agricultural inventories “sight unseen.” • Warehouse receipts can be used by farmers to finance their production, and by processors to finance their inventories. • In case of a default on any obligation guaranteed with the warehouse receipt—for instance, a bank loan—the holder has first call on the underlying goods or their monetary equivalent. • Collateralizing agricultural inventories will lead to an increase in the availability of credit, reduce its cost, and mobilize external financial resources for the sector.

11. WAREHOUSE RECEIPTS • Warehouse receipts contribute to the creation of cash and forward markets and thus enhance competition. • They can form the basis for trading commodities, since they provide all the essential information needed to complete a transaction between a seller and a buyer. • Their availability will increase the volume of trade and reduce transaction costs. Buyers need not see the goods, transactions need not take place at either the storage or the inspection location. • With a functioning warehouse-receipt system, commodities are rarely, if ever, sold at the warehouse proper.

12. WAREHOUSE RECEIPTS • In either case, the warehouse receipt forms the basis for the creation of a spot, or cash, market. • If transactions involve the delivery of goods on a future date, warehouse receipts can form the basis for the creation of a forward market and for the delivery system in a commodity futures exchange. • A broader benefit of warehouse receipts is that they increase the confidence of participants, particularly those in the private sector, in market transactions.

13. WAREHOUSE RECEIPTS • A warehouse-receipt system provides a way to reduce gradually the role of government agencies in agricultural commercialization. • Government intervene in agricultural markets to: • support prices, by buying directly from producers and, • guarantee a measure of food security. • To support prices, governments can accept warehouse receipts when prices drop below a support floor, rather than taking delivery of physical inventories. • Since warehouse receipts guarantee the existence of stocks, governments can achieve their food security objectives by merely holding these receipts.

14. WAREHOUSE RECEIPTS • The private sector will be responsible for purchasing, storing, and disposing of the physical stocks. • When private sector initiatives designed to protect market participants against price fluctuations develop-for through hedging in a futures market, the government will no longer need to play a role in this area.

15. HEDGING WITH WAREHOUSE RECEIPTS • Warehouse receipts can be combined with price-hedging instruments. • To provide lenders with secure collateral, in the form of warehouse receipts, and put a minimum value on it, through the hedging operation. • A secure WHR may allow owners of inventories to borrow abroad against export commodity in currencies for which real interest rates are lower, thereby hedging against the foreign exchange risk of foreign borrowing. • This practice is followed in Kenya and Uganda, where coffee stocks are often financed in pounds sterling. • The PTA Bank in Kenya finances coffee exporters by taking their warehouse receipts as collateral and also offers them a put option, purchased at the London Commodity Exchange that guarantees sellers a minimum price for the coffee they have in storage.

16. HEDGING WITH WAREHOUSE RECEIPTS • By assuring a floor price for the stored coffee, the PTA Bank can provide finance for a higher percentage of the value of coffee than it could justify in the absence of the floor price. • Banks will often advance 80–90 percent of the value of the transaction if it is hedged, but only 50–60 percent if it is not.

17. PRECONDITIONS FOR VIABILITY The legal system must support pledge instruments, such as warehouse receipts, as secure collateral, legislation must meet several conditions: • warehouse receipts must be functionally equivalent to stored commodities; • the rights, liabilities, and duties of each party to a warehouse receipt (for example a farmer, a bank, or a warehouseman) must be clearly defined; • warehouse receipts must be freely transferable by delivery and endorsement; • the holder of a warehouse receipt must be first in line to receive the stored goods or their fungible equivalent on liquidation or default of the warehouse; and

18. PRECONDITIONS FOR VIABILITY • the prospective recipient of a warehouse receipt should be able to determine, before acceptance, if there is a competing claim on the collateral underlying the receipt. • The lack of an appropriate legal environment is probably the single most important constraint on the creation and acceptance of warehouse receipts in many developing countries.

19. PRECONDITIONS FOR VIABILITY Operational conditions must be conducive to the creation of a warehouse receipt system that is; • reliable warehouse certification, guaranteeing basic physical and financial standards; • the existence of independent determination and verification of the quantity and the quality of stored commodities, based on a national grading system. • Inspection of warehouses and stored commodities performed, in most cases, by the private sector under license from a government body - for agricultural goods, usually the ministry of agriculture); and • the availability of property and casualty insurance.

20. An innovative WHR system funded by USAID around Kapchorwa in eastern Uganda’s corn belt is helping small scale commercial famers overcome two challenges – the cyclical nature of farm income and lack of access to credit. The scheme which has 2,100 members of Kapchorwa Commercial Farmers Association (KACOFA), is called Rural Saving Promotion and Enhancement of Enterprise Development (Rural SPEED). The Pilot Scheme is funded by Stanbic bank with US$200,000 loan capital and USAID’s Development Credit Authority provided the loan guarantee program, managed by Rural SPEED. KACOFA is also working with two other USAID programs to increase production levels, improve post harvest handling process and ensure the corn sold by Kapchorwa farmers is of good quality. UGANDA’S Rural SPEED

21. UGANDA’S Rural SPEED • KACOFA’s farmers deliver their harvest to a designated warehouse. It is weighed and kept under secure conditions until the farmer is ready to sell. • The farmer gets a certified receipt that can be taken to a local bank and converted into a loan; with the warehouse corn serving as collateral. • The loan is paid back when the corn is sold. • USAID Rural SPEED also sells to the World Food Program (WFP) high quality maize from the WH at 350 Uganda shillings/kg which is more than the 120-180 Uganda Shillings the farmers get from sales to local traders. • KOCOFA has expanded the WHR system to cover barley and beans and the rural SPEED model is being replicated in several other locations throughout the Country.

22. ETHIOPIA COMMODITY EXCHANGE (ECX) • Agriculture accounts for about half of Ethiopia’s economy (GDP), 60% of exports and 80% of Jobs. But the Commodity market is currently under-financed. Only 6% of traders are able to secure formal trade finance. • Farmers in Ethiopia have difficulty accessing finance due to the type and level of collateral that banks require. • ECX in collaboration with International Financial Corporation (IFC) introduced WHR financing to enable producers and traders get bank loans by pledging receipts for commodities held in ECX warehouses. • The ECX receipts guarantees quality, quantity and security of produce deposited in its warehouse. The Exchange provides a secure and reliable end-to-end system for handling, grading and storing commodities.

23. ETHIOPIA COMMODITY EXCHANGE (ECX) • IFC provided technical advisory services and financing for the WHR system and have worked together with ECX to increase the capacity of banks to extend loans based on WHR. • IFC is supporting ECX to design financial instruments, regulatory and legal changes to enable banks accept WHR as collateral for loans. • Traders on ECX have been able to use their produce to access bank finance since January 2010. • ECX was establihsed in June 2007 and commenced live trading on April 24, 2008.

24. WAREHOUSE RECEIPTS - BENEFITS • Collaterising agricultural inventories will lead to an increase in the availability of credit, reduce its cost, and mobilise external financial resources for the sector. • WHR contribute to the creation of cash and forward Markets and they can form the basis for trading commodities. • A WHR system provides a way to reduce the need of government agencies in the procurement of agricultural commodities.

25. WHR - LIMITATIONS • WHR in physical form suffer all the disadvantages of the paper form of title documents. • Need for splitting the WHR in case the depositor has an obligation to transfer only a part of the commodities. • Need to move the WHR from one place to another with risk of theft/multilation etc. If the transferor and transferee are at two different locations. • Risk of forgery

26. ELECTRONIC WHR - BENEFITS • Reduction in manual-paper handling. • Transporting paper documents is eliminated along with attendant risks. • Information is moved faster • An audit trail of receipt activity is kept and electronic receipt system serves to back-up receipt data for the warehouse. • Chances of forgery are reduced • The bearer of an EWR fractionalised it to thousandths of the whole as long as the whole never exceeds the quantity of the underlying goods in the warehouse. • (South Africa is running an EWR System).

27. WHR LOWER ACCESS BARRIERS WHR can be used to lower access barriers by attracting deposits from small farmers and traders, the system will help formalise their trade transactions enabling a database on their activities to be generated. • This will help overcome the problem of lack of track record, and enable banks to screen borrowers more effectively and with minimum delay. • Lenders can mitigate credit risk by using the stored commodity as collateral. • This form of collateral is more readily available to rural producers and may be less difficult to liquidate then most assets traditionally accepted as collateral. • Availability risk associated with moveable collateral can be reduced by the warehouse operator’s guarantee of delivery from a stated location.

28. WHR LOWER ACCESS BARRIERS • Foreclosure can be made simple and low cost without any resort to Courts depending on how the finance is strcutured. • The WHR system will also make it less necessary for lenders to monitor large number of small borrwers as a few warehouse operators assure loan performance. • This will reduce monitoring costs and encourage commercial lending to the rural sector, helping to capitalise the rural trade. • A lender holding a WHR has a claim against the issuer (the warehouse company) as well as the borrower in the event of the non-existence or unauthorized release of collateral. • The risk of loss of value of the collateral can be reduced by monitoring movements in its Market value as well as by margining and the use of price risk Management Instruments.

29. CONCLUSIONS • For developing countries where commodity sub sectors have undergone liberalization, the quick establishment of credit flows is crucial to the success of reforms. • Warehouse receipts provide a method of collateralizing crops and lowering the risk to the lender, thereby lowering financing charges to the borrower. • In addition, warehouse receipts provide a marketing tool to the emerging private sector, thereby allowing the orderly withdrawal of the state from commodity marketing. • In order to work well, warehouse receipts need a recognized basis in law, so that the ownership established by the receipt is not challenged.

30. CONCLUSIONS • Equally important are provisions for performance guarantees and the establishment of systems for warehouse inspection and crop-quality determination. • Concerted efforts should be made to alleviate the problems facing Regional Trade Arrangements (RTA) in Africa and to make regional trade an engine of development. • Regional Integration Agreements in Africa such as COMESA, EAC, ECOWAS/UEMOA, SADC and ECCAS/CEMAC supported by NEPAD are important vehicles for increasing Intra-African trade, creating wider economic space and promoting economies of scale.

31. Thank you !