Funding commodity trade Funding commodity trade | Photo Credit: Andrii Yalanskyi

India had exported approximately 32 million tonnes of foodgrains worth $12 billion in FY22, indicating our farm exports thrust. Our food processing industry is estimated at ₹2.24 lakh crores and is growing at about 11 per cent, ably supported by well-developed supply chains with the potential to deliver quality raw materials at competitive prices.

Exports and the food processing industry rely on robust supply chains and their connectivity with financial institutions to source cheap funds and raw materials. Given that agricultural commodities are seasonal, they need to be procured at competitive prices and carried forward. Besides adding to the costs associated with storage and losses, early procurement and storage locks in the capital.

Many of these processors operate with raw materials procured during the peak season and sell their products after a few weeks or even months, making them vulnerable to the volatility in the economy.

Such a business model, be it export facing or markets for processed products, will lock in a large part of the capital, crippling the businesses and their ability to respond to the market signals with agility.

Besides the quality of the raw materials, the traders and processors would also require a competitive financial environment and access to it. An expected outcome of a competitive financial environment would be access to cost-effective capital for traders and processors.

Apart from financing receivables, the commodities procured and stored (warehouse receipts) can also become effective collateral for the bankers to lend against. However, it requires active financing of commodity collaterals stored safely and securely, ensuring the quality and quantity of the commodity. Financing commodity collaterals will be an attractive proposition for the traders and processors to unlock that part of their working capital invested in stored commodities that otherwise serve to protect themselves from fluctuations in their input costs.

WDRA registered warehouse service providers (WSPs) and the issuance of eNWRs, are expected to ensure the quality and quantity of goods underlying the warehouse receipts. Like other physical asset classes, potential lenders with no expertise in the underlying would like to avail the services of professional agencies in physical commodities and commodity markets to help them in valuation, margins/haircuts to be maintained, analysis and forecasts about price movements expected policy announcements and their impact on collateralised commodities, and secure disposal of commodities in the event of borrower default.

Entities that provide similar services in various financial asset classes are typically called 'Asset Service Managers'. Due to a lack of expertise and resources to mitigate risks in lending against commodities, lenders usually hire third-party agencies to provide services such as valuation, market intelligence, protection against pest attack, asset inspection and audit, asset disposal, etc.

Are asset service providers new to the banking or NBFC sector? No, Immovable asset classes such as real estate, large machinery, industrial inventories, etc., are financed by the banks, as service providers for such assets provide the lenders with services related to risk management, asset takeover and disposal at the time of default.

Given the price volatility of some assets, lenders must manage the risk to ensure that the value of the financed assets does not fall below the amount lent. Independent service providers need to collect and share the asset price information on a periodical basis so that the lender can make adjustments to the margins and call for additional margins.

Asset service providers in commodities may also extend forecasting services to forewarn risks in commodity financing and advisory in areas such as stock limits, disclosure of storage, etc.

Finally, if the asset were to end up in default, the lenders, in most cases, would not have the experience or the expertise to handle the asset takeover and disposal process, wherein this proposed class of asset service providers help them for a fee. WSPs, as service providers on the ground dealing with commodities and knowing the local market conditions, can double up as both warehousing solutions providers and the service providers.

However, such a business arrangement extended to goods stored in their warehouses would result in a conflict of interest regarding their role as a WSP for the pledged collateral and as an asset service provider. Given that the physical safeguard of the commodities will now be taken care of by the fiduciary responsibilities of the WSP under the WDRA regime, these two roles should ideally be separated.

It will ensure the independence of audit and advisory about commodities underlying the eNWR pledged and its issuer WSP. Now with growing WDRA registration of warehouses and a probable mandate for all third party warehouses, will the existing species of collateral managers cease to exist? Perhaps not.

The collateral manager under the mandatory WDRA registration regime would not have to provide for the physical security of the commodity under an eNWR, and that would instead be taken care of by WDRA. However, all other services concerning advising and keeping the lender informed of the commodity price movements, assistance in commodity disposal, and market/policy advisory for a fee should be independent of the WDRA registered WSP's native responsibilities.

Should this fee be regulated? No, it shall instead be encouraged to be driven by competition that will finally enhance the availability of commodity warehousing and valuation-related skillsets at the ground level. Such services by the same WSPs shall only be regulated to prevent conflict of interests between the roles of commodity safekeeping under the WDRA regime and asset servicing.

The regulators can also use inputs from their audits and inspections to collect data with respect to compliance of WSPs for its use in stress testing of contribution to the proposed Depositors Guarantee Fund based on the risk culture of the WSPs. Such transformation of the 'collateral management industry' into an 'asset servicing business' will add value to the commodities sector's policy ambitions of increased financialisation.

The writer is with the National Institute of Securities Markets. Views expressed are personal