Why we need anchor warehouse service providers for commexes?

Despite the importance given to physical delivery in the exchange-traded forward or futures markets, commodity exchanges are yet to streamline their delivery process. Most of the contracts are cash-settled, while a fraction of cumulative open interests (in buy or sell a position) are settled physically.

The Forward Contract (Regulation) Act, 1952 makes a provision for both transferrable and non-transferrable specific delivery (TSD & NTSD). The Act says that besides the cash settlement, a proportion of contracts has to be settled by compulsory delivery.

Warehouse Service Providers (WSPs) can address this concern in association with an independent and common clearing corporation as proposed by the Working Group (2014) to the Forward Markets Commission (FMC). Exchanges thus need to create a conducive yet competitive business environment to WSPs that might restore the confidence of actual users in commodity trade. Nevertheless, emergence of systemic risk and free rider problem need to be checked by the exchanges and WSPs.

Delivery process The exchange requires at least three entities: accredited warehouses, register and transfer (R&T) agents and assayers to organise the delivery. The exchange notifies accredited warehouses to initiate the delivery. WSPs charge a service fee that constitutes storage and other costs, such as insurance, assaying and handling charges. The exchange deputes approved R&T agents who are responsible for dematerialisation and re-materialisation. The exchange empanels approved assayers for quality inspection.

The process comprises three stages: dematerialisation, re-validation, and re-materialisation. Acceptable delivery norms for dematerialisation include the standard grade of commodities known International Security’s/Commodity’s Identification Number (or ISIN/ICIN code).

Rate of premium and discount to the standard grade is imposed besides a validity date specified for each ICIN. In other words, commodities not conforming to prescribed standards are considered bad deliveries.

Key enablers StarAgri, NCML, NBHC, Shubham Logistics (Kalpataru), Central Warehousing Corporation (CWC) among others are empanelled members of commixes including NCDEX, ACE Kotak, MCX, and NMCE. These agencies attempt to adopt international benchmarking of storage practices.

Grain elevator might draw their attention as it has been an anchor service provider to several global exchanges. Public warehousing entity CWC has been managing the delivery of pepper, rubber at NMCE notified centres.

Warehousing service providers lease in licensed warehouses from private owners. A few agencies have started building their warehouses through project finance mode. For instance, NCML has constructed about 40 warehouses (including those under construction) with an average capacity of 15,000 tonnes.

StarAgri also forayed into a similar venture by creating 35,000-tonne capacities of both silos and dry warehouses in Rajasthan. It offers both professional and field warehousing service. Kalpataru of Shubham Logistics has also taken a step in this regard.

Bank lending is available to set up warehouses. NABARD’s (back ended) credit-linked subsidy scheme has been renewed to serve various entities in warehousing.

There is also a positive market sentiment for investment in warehousing and Collateral Management business, for instance, Star Agri raised equity capital of ₹400 crore and NCML, about ₹300 crore in the recent past.

Delivery status Delivery schedule comprises two categories: one is through exchange clearing process and the other, staggered delivery.

Recently, to expedite physical settlement, MCX initiated Exchange of Futures for Physical, and NCDEX promoted Alternate Settlement Mechanism. However, these are yet to gear up the volume of delivery.

Agricultural commodities account for a major share compared to metals and energy products.

Almost 15 to 17 agricultural commodities including plantation, spices, and oilseeds are reported under the normal delivery schedule and gold, silver under the staggered delivery schedule. While the volume of delivery has increased in the exchange notified centres across Gujarat, Rajasthan, Delhi, Madhya Pradesh, Karnataka, Kerala, Andhra Pradesh, Telengana, among others, Eastern part is yet to witness the volume. Exchanges need to empanel more service providers and launch more broad-based contracts in this region.

FMC may empower the exchanges and WSPs to streamline the delivery process.

Synergy in execution The Commission has issued the performance standards for WSPs in that the Exchange-accredited warehouses need to be registered with Warehousing Development and Regulatory Authority (WDRA).

Until September 2014, out of the 481 accredited warehouses, 56 Exchange-accredited warehouses were registered with the WDRA and 284 warehouses had been inspected by the futures exchange.

WDRA may also perform a key role in coupling the responsibilities of WSPs and assayers that might reduce the transaction costs of agents.

In addition, the Authority may help establish Negotiable Warehouse Receipt System (NWRs) and make the WRs a benchmark tool for pledge financing/commodity-based structured financing. WDRA intends to appoint some consulting agencies for a comprehensive assessment of warehouses in the country, and the project is expected to be completed by financial year 2017-18.

A report of the Working Group on Common Clearing for Commexes submitted to the FMC in October 2014 has proposed a roadmap for a robust surveillance and risk management system.

The report puts forward that clearing and delivery are inextricably linked in which accredited warehouses and e-registry of a negotiable warehouse receipts may be instrumental to enhance the magnitude of delivery.

The writer is is a Post-Doctoral Fellow of the Centre for Management in Agriculture, IIM-Ahmedabad.