The critical link needed to address warehouse receipt system price risk

A lot has been written about the warehouse receipt system (WRS) - a platform aiding farmers to hold their produce in certified warehouses where they can be tested, cleaned, graded and to receive a receipt as proof of ownership.

The idea was mooted as a way to minimise post-harvest losses suffered by farmers, to help them get better prices and gain access to collateral financing.

How does it work? Essentially, warehouse companies issuing these receipts (or warrants) ensure that the details are known to the WRS council, which acts as a central database, holding details of ownership and is subject to stringent security controls. Owners of these warrants can negotiate and transfer them to other parties.

Since its establishment in 2022, the WRS council has reportedly issued only 20 receipts and onboarded two commodities - grain and pulses, across nine certified warehouse operators. What appears to be missing is a critical link to exchanges for the sake of bank borrowers, who use commodities as their collateral, and desire to hedge against price risk.

But we’ve all heard the saying, “crawl before you walk,” or “walk before you run”, which usually implies figuring out the basics of how to do something and building up capacity before progressing to the next step.

That said, let me throw in my two cents on what the council can do to help us get there.

One, it can increase the participation of farmers by promoting the creation of groups in the form of co-operatives for increased bargaining power. Two, start building awareness for risk management as early as now amongst these groups and individual large farmers. Three, approve more warehouses and storage facilities across the country. This extension of its network is important as it goes a long way in boosting confidence. Lastly, clarify the question; are warehousing receipts really documents of title or are they just documents of entitlement?

Why is price risk hedging crucial? Volatility in commodity prices impacts different players in different ways. For farmers, a fall in commodity prices can decrease sales revenue, reducing their earnings. This means that commodities held as inventory under the WRS lose value if the price goes down, and gain value if the price increases. In other words, they’re still exposed to volatile prices.

This is why linking up a functioning commodities futures exchange is needed. In this case, the exchange’s commodity futures contract specifies that the grain must be a specific deliverable grade and what form of delivery is acceptable by listing the names of storage/ warehouses to which physical delivery must be made. Trades can be processed via the exchange’s clearing system.

Afterwards, when a futures contract proceeds to delivery, the clearing house manages the contract delivery of open contracts between clearing members and enables the delivery of documents to represent the underlying assets such as warrants on pulses. The buyer of the commodity (or holder of the warrant) presents this to a WRS-licensed warehouse and, upon receipt of the warrant, it will deliver to the holder the precise amount and grade of pulses that it represents.

Mwanyasi is MD, Canaan Capital.