warehouse receipts for food security: benefits and challenges

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Ag Sector Council

Warehouse Receipts for Food Security:

Benefits and Challenges

November 2010

Participants

Steve Mikkelsen - Director, Strategic Performance and Evaluation, Farm Service Agency, USDA

Robert Fries - Managing Director, Financial Services, ACDI/VOCA

Kofi Owusu-Boakye - Financial Management Specialist, Office of Development Credit, USAID

Moderator

Mary Ott - Acting Deputy Assistant Administrator, USAID/EGAT

Sponsor

United States Agency for International Development: Microenterprise Development Office

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Mary Ott: I’m really pleased to be here for this event. This is quite an important topic for

USAID. This event is jointly sponsored by the Bureau for Economic Growth

Agriculture and Trade and our new Bureau of Food Security. It’s a topic that’s

been of great interest and importance to all of us. In my various roles within

USAID and the various countries I’ve worked, one of the biggest puzzles that we

seem to have great difficulty solving is the puzzle of agricultural credit. I’ve

been in the agency long enough to remember back in the days of dreadful

public sector ag banks, and we’ve tried all different things within the

development community to find ways to extend credit to farmers. Many of

them have been quite challenging.

It’s always a pleasure to look at a model that has shown that it works, that it has

promise for even the poorest farmers, and that it can be implemented in a

variety of settings. That’s the model that we’re going to be discussing here

today, which is using warehouse receipts as collateral for credit. We’ve had

some positive experiences with this in the agency, which you’ll hear about later

in this session. For this reason, this is an important topic for us, as it’s

something that we no doubt will be looking into further as we pursue our

agriculture programs around the world. I think we have some good examples. I

think there has been material regarding a program in Tanzania that we can look

at, and we have other models as well.

Through this mechanism of collateral through warehouse receipts, we’ve been

able to pursue a number of possible benefits to small farmers. It’s a way for

them not to be forced to dump their crops on the market all at once and receive

low prices. It’s a way to have secure storage. It’s a way to have something that

can be recognized as collateral by banks, and it’s a way to improve their income.

There’s evidence of all of those positive effects through these sorts of programs.

So, I’d like to turn this over to our experts today who know a great deal about

this and many different angles. Our first speaker, who will provide background

and context for the use of warehouse receipts programs is Steven Mikkelsen,

Acting Director, Office of Business and Program Integration, Farm Service

Agency at USDA.

Our second speaker is Robert Fries, Managing Director Financial Services at

ACDI/VOCA, and he will talk about his experience of applying warehouse

receipts in three different countries to explore the extremes of what warehouse

receipts programs can look at.

Finally, my EGAT colleague, Kofi Owusu from USAID’s Office of Development

Credit will talk about warehouse receipts as they relate to access to finance and

will speak to the use of warehouse receipts in the Lindi region of Tanzania

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where our warehouse receipts program has recently showed much promise.

You’ve seen the bios of all of our speakers, so I won’t go over them in detail. I’m

sure you agree that we have an impressive set of experts on this important

topic, and I guess I will proceed by turning over the microphone to our first

speaker, Steven Mikkelsen.

Steve Mikkelsen: I’m Steve Mikkelsen with the United States Department of Agriculture, and I’m

in fact, with the Farm Service Agency. We’re the main interface between the

Department of Agriculture and most of the American producers. We have 2300

offices across the United States in which we sit down across the counter with

the farmers every day. So we are, in many respects, the face of USDA out there

in rural America.

Today I’m going to talk about the experience that the United States Department

of Agriculture has had and the United States Government in getting to where

we are with warehouse receipts, warehousing licensing over the past 200 years.

I’m going to start off with a quote here from George Washington, who you all

know if our first President of the United States, and I believe this is as true today

as it was then. He said, “I know of no pursuit in which more real and important

services can be rendered to any country than by improving its agriculture.” If

you don’t have food security, you’re not a secure nation. I don’t care what

anybody says. That’s where people’s hearts are. You impact their lives. You

impact their families. If you cannot eat, how can you survive?

US History – we started down this trek at least 150 to 160 years ago. 1848, the

Chicago Board of Trade held its first meeting. The Chicago Board of Trade is the

oldest operating exchange in the world. It is very interesting, Chicago, the

confluence of all agricultural products. It was a good rail transportation center.

It was just geographic location, location, location that brought the merchants to

Chicago up and through the 1850s that made it the dynamite city it is today and

still is because of agricultural trade. We had a lot of interest from congressman

way back in the 1850s. A congressman from Illinois suggested that the United

States need to have a bonded warehouse receipt law that people operating

warehouses should have to put up a guarantee for their performance. Fantastic

idea. It took us a while to get there though.

In 1856, the Chicago Board of Trade came up with the idea of a warehouse

receipt and uniform grain standards. What an interesting concept. Believe it or

not, these were not new ideas. They had used history to develop their thoughts

and their processes on how grain trade, marketing, warehousing should occur.

In 1871, New York started getting on the bandwagon with their own National

Board of Trade, which is now called the New York Board of Trade. In 1890, New

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York started the legislative process. In 1897, they came up with a Uniform

Negotiable Instruments Law and adopted it, but it took us until 1916 to get to a

federal law and 1954 for all of the states in the United States to ratify the

Uniform Commercial Code, which a portion of it is uniform warehouse receipts.

This is just a little page that shows how the states approved Uniform

Commercial Code and Negotiable Instruments Law. They took the original New

York concept and kept passing state by state by state. You can see I go up

through 1902, and I don’t have the rest on that list that went successively on

through 1954. Today on-farm grain storage in the United States is 11.9 billion

bushels, 321.1 million metric tons. That number has been increasing and

increasing and increasing. Probably 10 years ago it was 9 billion bushels.

Farmers are very much today taking control of their own grain storage away

from some of the concepts of warehousing. There’s a lot of issues around that,

transportation being big ones, consolidation, size, etc. It’s a very interesting

trend. The off- farm storage US warehouse space in the United States is 9 billion

bushels, 245 million metric tons. We also have cotton storage of 40 million

bales.

The United States Warehouse Act, which is regulated and patrolled by the

United States Department of Agriculture, that I mentioned started back in 1916

with our warehouse receipt law has 50 percent of the US capacity licensed

under its statute. 4.5 billion bushels of grain, 123 million metric tons, and also

50 percent of the cotton capacity, so you’re asking what happened to the other

50 percent? Well, the United States has states – state statutes, state laws,

state regulation. So that other 50 percent is controlled by the states.

Most of the members of the United States Warehouse Act are the larger firms in

the United States that operate in the multiple states. Many of the facilities are

companies that operate in one state. They may have a state license, but if

you’re operating in 3, 4, 5 states or 20, 25, 30 states, its easier to go the United

States Government and have one regulator than having to pay homage to 5

different regulatory authorities. So that’s why we’re essentially with the larger

firms.

Under the United States Warehouse Act we have 185 cotton warehouses, 2,700

grain warehouses, 25 other warehouses that are mostly peanuts. We have

1,200 inspectors, weighers, classifiers, graders. A very important fact of any

warehousing system is to have accurate weights and grades and they must use

the United States standards, even those that are in the state-licensed

warehouses. Everybody in the US must use the United States grain standards.

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Financial losses. We average less than $500,000.00 yearly over the last 10 years

on $60 billion of commodity handling. That number has been going down,

down, and down. Maturity of the program – everybody knows what they

should do, what they are responsible for. You can ask a grain trader, and they

can tell you what a warehouse is supposed to do. You can ask a banker. They

know what warehouse shouldn’t do.

The direct true history of the United States Warehouse Act – we were passed in

1916. In 1931, we had a major amendment to the act. The United States

Government and the states got into a big tiff about federalism versus state

rights and the legislature and the federal government legislature bodies made it

clear, the federal government is going to be in control. So, they did

amendments to a lot of acts, ours being one of them.

In 1947, we had a challenge to that amendment. It went to the Supreme Court

called Rice v. Santa Fe, and the Supreme Court also said we agree with Congress

that the federal government is prominent over the state. In 1988, we had a

ruling that was very interesting on the type of negotiable instrument,

warehouse receipts. It was a cotton case where used bearer warehouse

receipts versus to-the-order warehouse receipts. Depending on the commodity,

we use different types of receipts, bearer, order, negotiable, non-negotiable.

It’s up to the commodity how they want to function, but we have all of these

avenues and different facilities for them to take advantage of our system.

In 1999, we got into a court case of grain storage versus grain merchandising

and that one is still being played out. The essence of that decision is we should

be responsible for all grain merchandising as well as grain storage. The federal

government has only chosen to regulate grain storage, but the courts are trying

to push us on to a whole other level of guarantee.

In 2000, I made a major rewrite to the United States Warehouse Act. This was

confluence of many things that I had been doing. I started in 1995 with a lot of

overseas development of warehouse receipts systems. I spent a lot of time in

Eastern Europe and it caused me to reflect back upon the core issues and the

core values of what we’re doing with warehousing, warehouse receipts. I came

back to the United States and rewrote the statute in 1998. In 2000, Congress

finally passed it and the big major change was the adding of electronic

documents; not only electronic receipts, but also any electronic document it

takes to handle merchandising activities, in-transit documents, shipments from

A to Z, in the country, out of the country, within the country, etc. It was a very

interesting experience for me.

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The United States Warehouse Act is a voluntary statute, meaning you choose

whether you want to be regulated by us. It is not mandated by the federal

government that you belong to the United States Warehouse Act system. You

choose. Once you choose to be regulated by us, then we own you until you

decide you’re going to get back out of the system, but it essentially, as I

mentioned earlier, takes the state out of the play of regulating you. If you are

usually within a state, it is mandated that you either have to have a state license

or the federal government license, one of the two. You cannot operate a

warehouse without a license, okay?

There where we talked about earlier, storage obligations are regulated; not

grain merchandising, but the courts are trying to push us on into grain

merchandising regulations.

Okay, The Warehouse Act was developed to provide depositors with liable

protection, inspection bonding and insurance, produce a uniform regulatory

system for storage of agricultural products. We talked about the grades and

weights, and this is the biggie: firmly establishes the warehouse receipt as a

legal title to the commodity, which provided real loan value. One of the things

that Congress did in 1916 was to say all Federal Reserve member banks must

accept warehouse receipts as collateral. A major issue.

What we require from our warehousemen is they’ve gotta meet financial

requirements, maintain current active records, operate the facility in the

manner that protects agricultural products, maintain quantity and quality of the

product at all times. If it’s in there for 5 years, you put it in as US #2 hard red

winter, five years later you get back US #2 hard red winter. Not only that, if you

have a certain protein quality as well, say 14 percent instead of 11, you get the

14 percent back.

Development. Since 1995, I’ve been involved in developing warehouse receipt

programs around the world. I’ve lost track of all the countries that we’ve

started and stopped, worked with, still are working with. It has really taken off.

I’ve been impressed beyond belief how much the world has taken an interest in

agricultural marketing, development, warehousing, warehouse receipts. It is

really fantastic.

Lenders, in my opinion, are the rock. Program financing – I’ve been USAID,

various states, trade associations, World Bank, etc., etc. It’s really interesting to

see where the development comes from.

To develop a proper program, you need to have the following items. Integrity

and ethics of the supervising agency I cannot say enough about. If there’s no

trust in whoever the entity is supervising, I don’t care what you’ve got back

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behind it as far as guarantees, legislation, etc. If they don’t have faith in the

people running the system, you’re not going to get it going. Of course, you

don’t want to over-control either. Setting the right amount of control is very

important. Don’t oversize the government machine, and of course you need

funding and support services. You need a security, bond, indemnity fund.

There’s many different ways to do it. You’ve got to reduce or eliminate market

intervention. A lot of the programs that I was involved with in Eastern Europe,

that market intervention killed them. They tried to hang on to the old Soviet

style interventions. It killed them.

Grading standards, we talked about – need those. Supervision of the system,

with integrity. You need a legislative horse. Boy, that’s a big difference. You

might have one body, maybe a Senate, another body a House, or lower body.

Both of them need to be involved and need somebody to really push them and

have it as an issue for their country they believe benefits agriculture and

benefits market. Involve and educate all sectors. I can’t say enough about that.

You need everybody. I don’t care who it is. Anybody that touches the

commodity, touches the money, is involved – you know the old adage, “Follow

the money”? Follow the money everywhere. Get everybody educated,

convinced about this.

Public comment. Another one in the old Soviet style. They didn’t like public

comment on many things. They just say, “Hey, we’re going to do it. I’m in

control. Let’s make it happen.” It doesn’t work. You’ve gotta have public

comment. It gets all us folks involved.

A big one is one part versus two part receipts. Many of the old Napoleonic

uniform commercial code countries love the two-part warehouse receipt. It’s a

killer. You need to understand what the liens are on the commodity in addition

to the title on the commodity. They can’t be separate. You need to be able to

determine the price and value of the commodity at a glance. As soon as you

look at that warehouse receipt, somebody; a banker, merchandiser, needs to

know what the value of that commodity is today.

Redelivery, we talked about. Delivery on demand we talked about. Public

access. Publically announced fees and charges. Gotta have a public tariff where

everybody gets treated the same. No special deals for my best legislative friend,

which happened to accompany me in the country I was involved with, Romania.

The Chairman of the Senate Ag Committee happened to be the owner of the

largest export warehousing system in Romania. Death, absolute death.

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Warehouse receipt forgery. You might get by without it for a while, but as soon

as they realize – the criminals – that these documents have value, they are

going to try to steal it. You need to have penalties, administrative and criminal.

Rights of appeal for people who are contesting the grade they were given by the

warehouse, the weight they were given by the warehouse, but they didn’t get

the right amount of commodity or something back from the warehouse. You’ve

gotta have an appeal system for people to use that keeps it out of the court

system, makes it fast, simple, gets things settled, and move on.

Statute granting full and clear title, we talked about. Imperative. Short-term

collateral. Everybody needs to understand that most warehouse receipt

financing is short-term, nine months, six months; usually no more than a year

because you’re coming into the next commodity cycle. So everybody needs to

understand that it’s short term collateral, not long term.

Finally, the lender and the bank must be the person who has first place claim on

the grain and the commodity. The banker has to be number one.

Okay, with that, I’m going to turn it over to Bob and I’ll take questions, I guess,

later.

Robert Fries: Good morning. We’ve worked – we, as in ACDI/VOCA - Steve and I have never

met each other before today, but we’ve worked on a number of programs. My

role is not as intimately involved in the warehouse receipts. I’ve been asked a

few times to try to analyze across the programs we’ve been doing and to extract

some lessons from them. Perhaps the first one is embedded in that title slide.

We were asked to speak about warehouse receipts and its promise for food

security. I kind of cheated and I changed it to grain warehouse systems, and

that’s an element I think of the lesson here that will be woven through this

presentation.

We’ve worked with Steve, with other folks from USDA, with USAID, with EBRD in

a number of countries in the former Soviet Union, Eastern Europe and more

recently in Africa looking at this role of warehouse systems and warehouse

receipts for agricultural and rural development. I would propose to look at this

as three steps, and I do that analogy on purpose because with the staircase, it’s

better to start at the bottom and make sure that that’s firmly in place, which

isn’t to say that you ignore where you are going or already are assembling things

to make sure you can put the top step in place, but to break it in terms of first

and foremost there is accessible and secure storage. Secondly, there are rules

of the game and someone who is in place to enforce it so that all the players

understand basically what goes in terms of volume and quality is what is going

to be coming out.

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Then receipts, the documentation that shows all of the players; who owns

what’s in there and who has claims on it. In a nutshell, those would be the

three steps among the many elements that Steve has pointed out, that it gets a

lot more complicated than that; but from a distance, that’s the vision.

Let me put a little bit more detail behind it. When we’re looking at storage,

we’re looking at both the infrastructure – a lot of places don’t have the facilities.

They need upgraded facilities. They need facilities in more locations in order to

be effective to provide accessible and reliable storage. We’re looking at

management capacity. It’s one thing to have the building in place with the

physical capacity, but you need the management capacity behind it.

In terms of rules of the game, Steve mentioned that the incredibly important

part is grades and quality because the rules of the game are there to ensure that

what goes in comes out. If you can’t name what went in, you have a hard time

ensuring what’s coming out is the same. Certification and inspection system.

This builds on the fact that you are certifying that there is this management

capacity in place to maintain the value of that product that is being stored. An

inspection system that routinely verifies that that capacity is not only there, but

it’s being applied. Then these guarantees; things can go wrong and value of the

product can be lost while in storage. Are there insurance or self-funded

indemnity funds in place that allow the owner to cover that loss that might take

place?

When we look at the receipts, these, as I mentioned, are legal documents, but

along with them is a registry; whether it’s a paper registry or electronic registry,

as Steve mentioned, so that these receipts can be verified.

We found two very different experiences in Eastern Europe and in Africa, and

we found different experiences country to country, but the bigger difference is

where the context that we tried to apply these elements in these two regions of

the world.

In terms of storage, what has been put in place are larger public warehouses. In

Bulgaria, they are averaging 10,000 metric ton capacity. There’s about 50 of

them around the country, and they have been operating in the last 10 years,

building off a bit of the experience that Steve and others provided in terms of

technical assistance more than a decade ago. In Africa, we’re looking at trying to

develop a hub and a spoke concept. The size of the production units are

significantly smaller. The notion that these hubs, which would be certified

warehouses have on average 1,000 to 3,000 metric ton capacity, are quite a bit

smaller than what we’ve had in the Eastern European model. These spokes,

because of the transport costs that Steve made reference to and how that can

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be a significant barrier to a large number of producers – an interim storage

facility that may not be certified, so it doesn’t really enter the formal system

until it reaches the hub, but it allows for that aggregation at a more accessible

level for smaller producers.

In terms of the rules of the game and the umpire, state certification, inspection,

registry, these functions have been handled by

parastatal organizations most commonly in Eastern Europe. In the case of

Bulgaria, they were able to put in place an insurance system as well as an

indemnity fund so that with each deposit there was a fee that fed a system fund

to help pay out on losses that wouldn’t be covered by insurance. In Ukraine,

that final indemnity fund did not get put in place. In Africa, the question of the

confidence in the state and the capacity of the state to play the umpire role is

not widely held - that first integrity ingredient that Steve made reference to -

and grains councils, trying to set standards and rules of the game for the

industry itself and develop a form of self-regulation has been more the norm.

They don’t have the capacity and the staffing to reach out and provide a full-

blown inspection service, so it’s married with contracts with commodity

management companies, which makes it a little bit more expensive as well.

Insurance has been tapped in the Kenya experience and is planned for in the

Ghana experience, but indemnity funds have not been developed.

As far as the receipts itself, in Eastern Europe we saw negotiable and non-

negotiable receipts in Bulgaria. In Poland, a receipt was developed with a

negotiable and non..it was a two-part receipt. When we looked at it last year

we found that the vast majority of the deposits are not documented with

receipts. The depositors don’t want the receipts. The buyers don’t want the

receipts. This notion that the receipt could be transferred over to the buyer and

the buyer could go and collect the grain instead of the depositor is not attractive

to most of the buyers because they don’t have confidence that if they go, the

available deposit will be there, and they’d much rather the depositor be

responsible for picking up and delivering. So, a large part of the benefits of the

system are not there. Without the receipts, you don’t have the same form of

collateral with the banks.

In Kenya, the notion of being able to move that legislative horse to get in place a

receipt that was a legal title was challenging, had its standing in the law itself.

They have attached a receipt managed by the grains council to contract law and

attach it to contracts. That makes it a more cumbersome product, but it makes

it effective. For banks who are willing to accept it, it’s starting to get financing.

It’s starting to be a source of collateral.

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As I look across these things, there’s some common challenges. Steve alluded

to a few of them. Trust within the system becomes imperative. The legislative

framework, the legal framework that was invested in Ukraine hasn’t been taken

up at the base level because there’s a strong skepticism about the reliability of

the warehouses and being fairly treated; that the weighing would be fair, that

the grading would be fair, that the capacity to dry your grain rather than burn it

was there. So, having in place more sophisticated legal framework, while

potentially helpful, has not been realized because of the lack of trust.

The constant challenge is what is the appropriate legal environment? It would

be great to have a receipt with full legal backing. So, do you wait until that’s in

place or do you try to attach yourself to what’s already on the ground, as has

been attempted in Kenya. Government interventions in Kenya, the first year – 2

years have gone through in this pilot effort. The goal is 5 years to be more than

100,000 metric tons managed through its system and that is self-sustainable.

The first year 1,000 metric tons was the pilot goal. They achieved that. The

second year they were trying for 8,000 to 10,000 metric tons and didn’t come

close. We’re faced with the situation with the government, I believe, dumping

some imported grains at very low prices, which put into question how

predictable is the price pattern?

And, a viable business model. I think this is captured best by this graph, which I

recognize is hard to read, but there’s a straight line that starts with some fixed

costs of 5 cedes per 100-kilogram bag, and then you see how the price has

fluctuated. In 2007-08 cycle, it was very attractive throughout most of the

period to pay the cost of storage and sell your grain later in the year. In the red

and the yellow years, it fluctuated. In the pink year, it really wasn’t that

attractive. The smaller the producer, the greater the percentage of fixed cost is

to that variable storage fee across the year, and so it becomes more

problematic for them.

We’ve talked about benefits that are not just collateral and finance-based.

Reduced losses from reliable storage that farmers may not have. A longer sales

window even if they don’t have a full system in place. Transparent quality,

fungibility of a stored product as opposed to keeping them in separate bags in

the warehouse. Incentives in place to improve quality with grades and

standards in place. Improved storage and trust of depositors, buyers, and

lenders in the system if you can get into place these more sophisticated legal

frameworks and performance guarantees. Finally, a solid pledge instrument,

more efficient commodity sales because you can just sell by trading the receipts

and the basis for commodity exchange are bigger benefits at the top of the

staircase.

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I would say that building the system has benefits throughout. Systems get

bigger at the top, but for smaller producers in some of the poor countries that

we’re looking at agricultural development challenges there are benefits that

accrue along the way. Thanks.

Kofi Owusu: Good morning. My name is Kofi Owusu, and I am with USAID’s Office of

Development Credit. The DC Office, as some of you may be aware, has

supported USAID’s development initiatives in many sectors where access to

credit has become a constraint. As of the end of the last fiscal year, we have

made available about 2.3 billion dollars in credit guarantees throughout the

world. At some point over the past 12 years or so that we’ve been doing this,

our missions have called on us to use a guarantee to support the beginnings of

warehouse receipt systems for the simple reason that, as Steve indicated

earlier, banks and I will use the word financial institutions play a crucial role in

making warehouse receipt systems work. They give loans and they provide that

link that converts the deposits into cash.

Because of our experience working with banks we have, as I indicated, been

called on to help banks bring them closer to using their credit instruments to

support these initiatives in warehouse receipts lending. We have had a lot more

misses than hits, but in those misses we have learned quite a bit. Today, I want

to use this occasion to share with you the one significant hit, if you will, success

story that we have observed. This one was actually achieved in concert with the

African Development Bank.

Two years ago, we signed a joint guarantee agreement with the African

Development Bank to provide access to credit to agro businesses in Tanzania

broadly read. Unbeknownst to us, the bank had their own plan of using this

guarantee scheme, which was $20 million to support the gradual transition, if

you will, into warehouse receipts backed lending. Now, because the law, the

warehouse receipts law, which they now have in Tanzania, was put on the books

in 2006. Frankly, none of the banks had made any effort to tap into it. This, I

would say, was quite an ingenious plan by the bank to use or to work with the

development community to reduce the perception of risk that they saw in

agriculture.

So, they used as guarantee instead of the pilot initiative in perhaps one of the

poorest regions in Tanzania, which is the Lindi region, about 540 kilometers

outside of Dar es Salaam. The goal was to see how well they could make loans

within this region to cashew farmers and producers by organizing them, using

their own resources to pool the small holder producers together and bringing

them up to scale in terms of teaching them the skills, the management skills if

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you will, needed to be able to access credit, but also to be able to tap into the

warehouse if that was freely available within that region.

So the bank observed a few key risks that I wanted to point out here in a sense

that in our experience, especially in Zambia previous to this experience, we

realized that the development community in general, and I think especially

USAID, because of our specialty in working with small holder producers as well

as in working with the commercial and the value chain work that we do, we

tend in our engagements with the warehouse receipts sector to not focus as

much on the banking side and we neglect that, if you will, at our own peril. I

think that was the experience that we saw in Zambia where we had done quite

a lot of work with the small holders, bringing them together into associations,

aggregating their produce. But the bankers still did not have any faith in the

system that had been created, the legislative environment within which they

were working. They didn’t have confidence that indeed this receipt will give

them the rights of ownership should the farmers not be able to repay the loans

that they had given them up front. The bank, CIDB Bank in Tanzania wanted to

address this borrower risk, if you will, but forming these Agriculture Marketing

Cooperative Societies.

Now, AMCOS or cooperatives in Tanzania was not a new thing, but I think the

experience, according to what I heard from the banks as well as from the

cooperative managers was that over time the strength of the cooperatives had

been weakened by centralization. The warehouse receipts law essentially

decentralized the power of the cooperatives by making these AMCOS essentially

responsible for being able to make moves without necessarily getting the

blessing of the mother ship or the mother cooperative.

So the bank formed a task force whose main objective was to actually go into

these very remote regions where they didn’t necessarily have any branches, but

then they had a mobile banking unit that would drive out there on a weekly

basis to make disbursements as well as to make collections. Then they had this

taskforce whose job it was to go out into these remote areas where producers

were bringing together these weak associations, teaching them, investing in

their capacity to manage their produce as well as enticing them with financing

for imports.

So the bank made a strategic decision to train borrowers so that they could

reduce the risk associated with making loans against the receipts that these

aggregated borrowers or these associations would present to them during the

harvest season. One of the main risks that he observed was the risk of side

selling; the idea that they would train these associations and eventually at the

end of the season because the borrowers didn’t have any faith in this future sell

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or this promise of better prices in the future or in a few months, they would sell

on the spot.

So, it was a real risk that they took, but I think they also had – and this is a

perhaps a question that will be addressed later – they had this thing called the

cashew board, TCB, Tanzania Cashew Board that set a guaranteed flow price, if

you will, at the beginning of the season. That flow price allowed these small

holder producers or gave them an incentive to sell back to the associations so

that they would promise the additional disbursements as opposed to just one

time selling it to the traders who would come through the villages. So that

reduced the incentive to side sell, having that flow price.

The other risk that they anticipated was the warehouse risk, and I think that the

previous speakers alluded to that. The idea that you needed to have integrity,

the banks not only needed to have faith that the deposits or the receipts

reflected what had actually been deposited, but also that the quality will be

maintained while they were deposited at the warehouse. So the bank through

these taskforces went out there and created personal relationships because

they don’t have public registries that they could easily tap into to verify the

veracity of these receipts.

So, they actually had to create relationships with the warehouse managers so

that when the receipt was presented to them by one of these AMCOS that they

had trained, they could also make a quick phone call to verify, but indeed

deposits of this quality and this amount had been made. The final risk that they

wanted to control for was in the price risk that the risk that the prices of these

commodities would go down after the end of the period that they expected to

gain some increases in. That risk was somewhat mitigated, but not exclusively

by the idea that there was a market for cashew nuts. The market previously

was being sold in an informal sector to various traders coming through. Now

that they had this warehouse receipts law in place, it required that the

warehouses or cashew be sold through an auction basis.

So, associations and the AMCOS were incentivized to make deposits with the

expectation that the bidding process of the auction would yield them higher

prices, but this was a key risk that they had to mitigate for. That is also one of

the key reasons why the guarantee was especially useful here because if the

prices did not materialize, they were at least guaranteed a certain degree of

repayment up to 50 percent according to our shared risk guarantee with them,

with the African Development Bank providing the key component of that risk

provision in USAID managing it.

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So, I want to start with you here, the case study of what happened last season

according to the bank. So, during the preseason, as I indicated earlier, CRDB

would work with these AMCOS by in some cases starting ones from scratch. So

they would send task forces out there to go into the villages, aggregating the

various cashew producers in that village, forming associations, helping them to

write association constitutions and registering them as a legitimate association

with the AMCOS hierarchy or the AMCOS board. In that process, they would

also educate them. So we saw AMCOS managers who had received hands-on

training from members of the CRDB team with the skills necessary not only to

track the deposits that were coming in from their members, but also to be able

to identify which techniques would yield the best results because at this

particular point, quality translated to premium prices.

The quality of the produce coming out was mitigated by the fact that the bank

was investing in the training of the small holder producers. Then, during the

harvest season, the AMCOS would aggregate. That’s when the bank would

make a loan, would make the initial loan to these farm associations to buy up

the produce at the established market price with the expectation that once the

produce has been adequately aggregated, they would deposit it at the

warehouse. The warehouse would issue them this warehouse receipt with the

quality and the grade and the quantity stated explicitly on it, and then they

would use that receipt, return it to the bank, and the bank would issue them

another loan. So, essentially it became a revolving credit line, but the key risk

for the bank in this particular instance was at the beginning of the season where

no deposit had yet been made, and so they had to be sent to pre-finance the

AMCOS with the capacity to buy up the initial produce that they were collecting

from the association members.

Subsequent purchases were financed at 65 percent of the market value of the

receipt. So, the association managers would bring their receipt and the bank

would make them a loan for 65 percent of the value, and then they would in

turn use it to buy up more produce from the producers. Essentially, what that

ended up happening was the producers would get 70 percent of the farm-gate

price. In 2009, the farm-gate price was established at 800 Tanzania shillings per

kilo, but during the season where they are doing the auctions and during the

sale season, that is where various buyers usually from Asia or from the Middle

East will come in to inspect what has been deposited, and then offer their

tenders for how much they want to buy it for.

As the bids come in, they would aggregate and average the prices and sell it to

the highest bidder. In 2009, during the last season what was being sold at 800

Tanzania shillings per kilo eventually were sold to the buyers at 1530 Tanzania

shilling per kilo. Once the sale has been completed, the bank would deduct

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their original investment as well as the warehouse would also take out the

storage and associated expenses with the warehousing. Then the remainder of

that sale funds would return to the AMCOS managers for redistribution, which is

what they call the second distribution or the second payment, which essentially

will bring the farmers whole; bring them up to the level of the original farm-

gate. From the 70 percent, another 30 percent would make them whole.

The key bonus here is with the third distribution, which is what is left over after

the farmers have been made whole of the original farm-gate price. Last year, 60

percent of what the association has left after they pay all of the expenses

associated with the warehouses is required by law to go back to the farmers

proportionately to what they have already deposited. In this particular

instance, farmers received about 20 percent of the auction sale price back to

them in the form of this third payment.

After this initial example of having seen it work and the farmers having received

these payments, the demonstration had been made. It wasn’t as tough an

uphill battle if you will, trying to convince more farmers to aggregate their

goods in the next season. So, the model was proven after the first season.

I want to share with you some thoughts overall based on our experiences with

some of these places like Zambia and now Tanzania of what has and what hasn’t

worked and the role that credit guarantees can play in it. It is fair to say that

credit guarantees or the availability of shared risk, credit enhancements are no

panacea for weak or non-existent institutional frameworks. I think we tried to

convince banks to make loans against warehouse receipts. We couldn’t have

traditional structural standing with the expectation that the bank would feel

confident because they had a 50 percent guarantee. Banks are not in the

business of selling coffee or corn or even cashew. They want the trust factor to

be there that the grain maintains the quality that it says so on the receipts, and

also that in case of default the rights of ownership transfers to them.

Credit guarantees will never incentivize the bank to guarantee in and of itself.

Then, credit guarantees can also be an effective to the warehouse receipts

systems, especially during the initial stage where banks are naturally wary of

new products or new systems. Agriculture especially is one of those sectors

where banks – well, in my experience in Africa have been very, very, very wary

of getting engaged in. So, giving them the added layer of guarantee assurance

with a shared risk arrangement on top of the discounted prices that they are

giving these warehouse receipts gives them more protection than they need

and the comfort needed to get exposure, experience it, and then be able to do it

without a guarantee in the future.

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The partnership with the right financial institutions – and I use the word

financial institution instead of bank purposefully for the simple reason that I

think the aggregated nature of these small holders naturally placed to the

advantages of microfinance institutions because working with big banks, that

was one of the mistakes we made in other places. Working with big banks with

branches remotely situated from the small holder producers do not yield uptake

of these systems, but rather finding the right institutions that have a hunger for

wanting to spread their branch networks, have a localized workforce that

understands these systems has a very positive role in helping the banks take up

these new innovations in Ag finance.

Finally the demonstration effect. One positive thing that I saw in Tanzania was

other banks were getting into the action because they have seen this CRDB bank

model working positively. They have seen the task force at work, and they were

actually in a market to coach some of the associations that had been trained by

CRDB, and that is the kind of thing we want to see encouraged; see other banks

see the positive benefits of agricultural finance backed up by warehouse

receipts and be willing to engage with that sector and that space on their own.

While I have your attention, I will put in a plug for access to financial

information sources that we, the Office of Development Credit have put

together. You can follow us on Twitter. You can visit us on Facebook or you can

subscribe to our weekly newsletter. I think you will find it very useful. Thank

you. I think the real fun part begins with the questions.

[Applause]

Moderator: Okay, I would like to thank our panelists for a very interesting set of talks. So, I

invite you to give your questions to the panelists. For those online, you can type

in your questions and we’ll try to ask them here in real time. I’d also put in a

plug to – you had some surveys on your chairs. If you can fill those out before

you leave, I would greatly appreciate those, and you can put them outside the

door. With that, please give your name and organization when asking a

question and we can start.

Jim: Jim Yazman, Office of Agriculture USAID. Question for Steve, does the grades

and standards system in the US have to take into account now organics and

GMO food commodities in the warehouse receipts system? Do we have to keep

organics separated from non-organics?

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Steve Mikkelsen: No, it is not required, but our system has always had the option of adding

additional remarks, comments about the particular commodity that you may

want to store or handle. One of the methodologies is called identity-preserved

storage, but if you want to agree with the particular warehouseman that you

want your lot held separately from anybody else because certain quality factor;

whether it be GMO or something else, usually they will work with you. You’re

going to pay a little more on the storage price for that type of thing, but it also

depends on how many other customers they have trying to do the same thing.

We have certain places in Iowa where they have been into certain particular

varieties of soybeans that are very demanded in the market in the Orient and

they’re feeding that.

So, it started many times with one or two, three, four, five growers and has

expanded to 100 in the community. So yeah, our system allows for that.

John: John Lichte, Abt Associates. I’m concerned about the price risk particularly in

situations like Africa and West Africa. Some work that was done by the

INSORMIL CRSP seems to indicate that they believe that in West Africa ,based

on limited data I’m sure, that they expected warehouse receipts to provide

benefits to farmers perhaps two years out of five, lose money two years out of

five, and sort of be neutral the fifth year. That makes the whole issue of

investing in warehouse receipts, investing in new warehouses that would be

necessary because most of these areas don’t really have the infrastructure, the

trust that one might have, the interest of the financial institutions to invest in

things that may lose money half of the time. This thing has been treated a little

bit like a silver bullet and yet not being addressed in a risk management context,

which it seems like it should be. I’m just wondering about your reaction to that.

Steve Mikkelsen: I’ll go ahead and take a stab at it. Commodity markets in the United States are

free to trade up and down however they wish. One of the biggest assets for any

country or any product is the ability to produce a produce on a quality and

timely basis. If you’re a reliable supplier you’re going to get a premium in the

marketplace. So, looking at past statistics where based on our actions of the

last 20 years, it’s a 2 out of 5 chance. Yeah, I can see where they come up with

that, but as they say, give me a set of numbers and I’ll give you anything you

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want. It’s really about feeding that market, being a supplier, good producer.

You’ll find a good market.

Kofi Owusu: I think I’ll piggyback on that by saying that the market for the particular

warehouse good in terms of the quality premium that is added to that – and I

will use the Tanzania example. You had associations that were previously just

collecting anything and selling to the traders that would come through the

village, but the introduction with the warehouse receipts model where cleaning

and moisture content and quality premium cashews were now receiving a

higher price. There was an international demand for the product. I think the

selection of the commodity in question is a key component of what you are

referring to. So, for cashew for instance, there is demand from the Middle East.

There is demand for it from Asia.

For that reason, those buyers are paying a premium and I think when producers

are made to understand that if you produce quality cashews, for instance, you

will get a higher price, and the bankers through their experience with the prior

season of guaranteeing or making loans against quality cashews, it mitigates

somewhat –not exclusively – the price which you are referring to. I think the

solution is going to be adding the price premium that comes from investing in

quality produce.

Steve Mikkelsen: I’ve got one other short comment. Many of these developing countries have a

50 percent loss of the commodity in the countryside before it ever gets to the

marketplace, so that in itself is a huge bonus that you can essentially double

production and you didn’t plant an extra acre. Yeah, quality control after you’ve

harvested.

Robert Fries: I made reference to the challenge of the business case, and I think this gets right

at the heart of it. I think there’s a couple of implications. If the warehouse

receipts system is seen as a silver bullet in the short term to benefiting small

farmers, I think that’s an unrealistic expectation. There is a speculation

dimension to this and there is a fixed cost dimension, which makes it less cost-

effective for a small farmer to pay the cost of storage over time and try to reap

the benefit of the price. Aggregation, traders, and other players, there’s a

better fit for. I’d love to be able to see the data that say it doesn’t move

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downstream over time, but the registries just don’t capture that data very well,

at least as I’ve been able to find, and that might be a good investment for a

community of donors to look at because there is great promise.

The second thing, as both have alluded to, improvements in reductions in loss,

incentives for producing to a better grade or standard because there is a grade

and standard in place and looking at this as a set of steps building from the

bottom where you’ve got an appropriate link between the risk and the

credibility of the system and confidence in the system and what the system is

comprised of at that point in time is how you have to look at it rather than

focusing exclusively on the grand slam home run of a warehouse receipt system

that’s completely anonymous.

Steve Mikkelsen: Yeah, it is basic step, preserving the quality of the product first. Once you have

the quality of the product integrity, then watch the markets grow. Your cash

market will take off, and eventually you want to get to the place where you

have a futures market so you can look forward and determine what prices are

going to be in the future, what you’re going to plant, what you’re not going to

plant, how much you’re going to plant. It all comes together over time, but

these are the basic steps. You’ve gotta get step one first.

Moderator: From Muhammad El Hawari with Andalusia Financial in Cairo, Egypt, and he

would like to know the warehouse receipt system is obviously very important

for starting a commodities or futures exchange. Did any of the developing

countries you helped launch the system in, evolve enough to start a

commodities or futures exchange?

Steve Mikkelsen: Some are still working on that. That, again, is in my opinion, the last step that

any country will take. As the US example, we had a market starting with a

Board of Trade and went backwards and then came back up the ladder. That

doesn’t work normally. It just doesn’t work. Normally, you’ve gotta have the

basic steps, the quality control, the warehouses, the system of cash operating,

and you’ll see a cash market emerge initially and later on a futures market to

serve the cash, but the futures is the last.

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I went to, I believe it was Romania, and the first thing they wanted to show me

was their new Board of Trade, which they had used US money to develop. I

walked into the trading floor, and it looked exactly like a living room where you

had coffee every day; not trading coffee; you drank coffee and had pastries. I

said, “Well, what is this? Where is the floor?” They had not traded a thing in

two years, but they called it their Board of Trade. They did not understand the

steps as we’re discussing today that first you’ve gotta have the base instruments

in palace to make a cash market happen and then work up to the futures.

Robert Fries: I’m not certain. I have not really looked at the evolution into the futures

markets. One thing I would recommend and I mentioned to Steve earlier is a

recent paper came out by the FAO called Use of Warehouse Receipts Finance,

and it’s a really good analysis qualitatively of the pieces of the systems that have

been put in place in different countries. It captures a moment in time 2008 to

2009. I believe one of the elements in there was the extent to which it was

linked with commodity exchanges or not, but I don’t recall explicitly, but that

gives a good snapshot of a wide number of countries, and how they have

applied or not been able to apply the range of these elements.

Steve Mikkelsen: For example, in Bulgaria that you spoke of, we had US traders use the Bulgaria

system in worldwide export markets, and they used the exchanges around the

world no matter what the commodity that best suits them, whether it be here

in the United States, whether it be in the orient, whatever the case may be. So,

even though Bulgaria itself may not have a futures market, there are established

futures markets all over the world that people use no matter what country you

are in today. One of the best ways to access that for your country is through a

licensed warehouse system with valuable warehouse receipts that can be

issued, negotiated, and eventually delivered upon for a futures contract.

Dawn Thomas: Thank you. Dawn Thomas from the Office of Agriculture. I want to, first of all,

thank you all for the excellent, excellent presentations and say how terrified I

think it is this wonderful manifestation of collaboration here. The question I

have is addressed to Steve, and it’s actually a two-part one. In your presentation

you spoke about some of the requirements for a sound system including ethics

integrity and one of the things you mentioned was funding of support services.

I wondered if you could say just exactly what you meant by that. What would

be some examples?

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The second part perhaps relates to a question that someone else asked earlier,

which had to do with success in Francophone countries. You mentioned that

there is a one part or a two part system, and in the countries with Napoleonic

experience, they tend to go for the two-part system. Could you explain that a

little better, and perhaps we could understand a little bit more why in the

Francophone countries the experience is as it is?

Steve Mikkelsen: Okay, the first question on supervision. Supervision needs to be applied to the

system you’re developing in a proper manner so that we get to the level of

integrity and confidence by all people involved in the grain trade. I’ve seen it

done two ways; over supplying manpower and undersupplying manpower by

whoever the authorized entity is that’s going to “supervise” the system. Again, I

believe it was Romania – they wanted to take an old system that they had in the

Communist style that was essentially their quality control graders, of which

there were something like 5,000 employees and dump them onto warehouses

and warehouse licensing.

I gave them the example of the United States. Here we are monitoring $60

billion worth of commodities and we have less than 100 employees. You’re not

going to get there right away. You don’t have quite the infrastructure we do,

but you sure in the heck don’t need 5,000. So you can overkill it and you can

underkill it. What happens with the overkill many times is it ends up being

graph corruption side, back pay. Those guys aren’t paid enough to do a proper

job, and they’re all of the sudden part of the fraud scheme. Underdeveloped is

you’ve got 5 employees. I think we were looking at Indonesia. I did a lot of

work with them over the last year. They were talking about an office of 5

people or 10 people that they might apply to this system. Come on. You’ve

gotta have a system or you don’t have a system. It’s gotta be the right people.

They’ve gotta be educated. They’ve gotta understand agricultural markets. Just

because they have a Masters degree in economics doesn’t mean they

understand agricultural markets. You can overkill it, underkill it. There’s a lot of

different ways you can mess up supervision.

The second question on one and two-part receipts. The two-part receipt is an

instrument that was developed in the Napoleonic commercial code or common

code, whatever I think they called it. Somehow in their system they believed

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that you would rip apart in two different streams the collateral size or the food

putting lean against the commodity versus the face of the commodity, which

actually shows the title to the commodity. They’d run it two different routes.

Well, that worked fairly well for the bankers because they could keep it right

close to their vest, but it absolutely killed the marketing side because nobody

knew how much to pay for it. Which bank had the lien? Where is it? Once you

separate the two, you’ve got disaster. You’ve gotta be able to at a glance with

one document whether it be electronic or paper or whatever you’re using, to

determine the value of that commodity and the liens against it. So that’s why it

needs to be one receipt.

Now, we’ve solved that issue several times in several countries by saying, “Okay,

we’ll take the old code and allow the two documents to exist,” but when we

printed them, we made sure that there was a perforation where we could

separate the documents. It was integrated into one document and they

couldn’t cut around it. So that’s just a little American capitalism there, applying

common sense to a system that didn’t work.

Kathleen Curtis: Kathleen Curtis from the Academy for Educational Development. I also want to

thank for a very interesting set of nice complimentary talks. I just wanted to ask

about how to view this. How much can the smallholders benefit versus the

large holders? Is somebody too small to be able to participate or does it depend

on co-ops? The 30 metric tons was about the smallest I saw. So how do

smallholders take advantage?

Kofi Owusu: Without forming associations you mean? I think the Lindi model that we show

in Tanzania answers your question quite well in the sense that in some of the

most remote places where there is no electricity, no bank branch, but if you can

put in the support services to be able to aggregate and train the farmers so that

they see the benefits of aggregation in the first, second, and third payments,

after they have seen that, it doesn’t matter how little you can produce. You can

be part of or a member of one of these associations. You receive the benefits of

the increased prices or the premium that comes with having quality produce.

I believe what we are seeing in Tanzania, certainly the benefits of the

warehouse receipts; however, which way it is adapted to the circumstance of

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the country in question, the benefits ultimately will affect everybody within the

value chain from the very smallholder farmer to the traders and the processers

as well as to the buyers who buy in bulk. Ultimately, the price benefit touches

the smallholder farmer if they are a member of an association; otherwise, it’s

too small and the cost of warehousing precludes any benefit coming to them

from just taking a warehouse storage unit on their own.

Moderator: I’d like to thank the panelists. We’re kind of running late on time. If you have

any additional questions, feel free to send them to agrilinks, that’s

[email protected], and we’ll try to follow up and connect you with the

speakers. Once again, I’d like to thank the panelists for a great presentation.

[Applause]

[End of Audio]

warehouse receipts for food security: benefits and challenges

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