Finance Roll

Warehouse receipts are a crucial element for risk mitigation, enabling a financier to lend to a borrower, who wants to finance the shipment of commodities for sale or purchase. Using warehouse receipt finance, a bank, or trader, relies on goods in an independently controlled warehouse to secure financing. Usually providing (among many things) there is an off-taker and that there are other forms of recourse (the borrowers balance sheet for example) banks will lend against commodities stored in a reliable warehouse and which have been properly pledged to them in a sound legislative environment. So warehouse receipts provide for a degree of physical risk mitigation and, in support of an exchange-based trading system, they are important for underpinning futures.

Accordingly, warehouse operators can act as key influencer's of risk management. If they are able to issue warehouse receipts, which can be used as collateral by banks, they may use this as a way of encouraging deliverers of commodities to move stocks into their facilities. Warehouse operators receive goods into the warehouse and issue receipts showing the goods have been received into the store. Among other things, the receipts themselves contain information about the quality and type of the commodity taken into store. The receipts are for the information of the depositor of the goods or, if he is a borrower, for his bank. However, these receipts are not negotiable documents of title, i.e. the title to the goods themselves may not transfer from one to another person via the passing of the related warehouse receipt.

Herein lies the potential for some degree of confusion. The term warehouse receipt means different things to different groups of people around the planet. For example, in the United States, the term ?warehouse receipt? is used for a document evidencing storage of a commodity in a warehouse. Unlike elsewhere, it is a document of title, supported by legislation; in this case the US Warehouse Receipts Act of 2000, which replaced a piece of legislation enacted in the US in 1916. By contrast, in the United Kingdom a warehouse receipt is a non-negotiable instrument simply notifying that at a certain moment in time a certain amount and quality of a commodity was delivered into a warehouse. In the UK, a negotiable form is represented by a warehouse warrant of the type issued by London Metal Exchange-nominated warehouses.

The main advantages of warehouse receipt financing from a risk management perspective are:

The identity of the collateral is less contestable and the intention of the borrower to pledge it is clear, avoiding ownership disputes and competing claims. The collateral can be auctioned or sold promptly and at low cost if there is a loan default. A lender holding a warehouse receipt can claim against the issuer (the warehouse company) as well as the borrower in the event that the collateral goes missing. In a bankruptcy scenario a document of title can cut off the claims of competing creditors.

Warehouse receipts can be negotiable or non-negotiable. A non-negotiable warehouse receipt is made out to a specific party (a person or an institution). Only this party may authorize release of goods from the warehouse. He may also transfer or assign the goods to another party, for example a bank. The warehouse company must be so notified by the transferor before the transfer or assignment becomes effective.

The non-negotiable warehouse receipt in itself does not convey title and, if it is in the name of, for example, a trading firm, it needs to be issued in the name of or transferred to the bank in order for the bank to obtain more than just a security interest. A security interest is much less attractive to a bank than if it has what is called possessory collateral, i.e. it has direct recourse to the warehouse where the goods are stored and in the event of a default or similar, it is easy for the bank to sell the commodities in a shorter time frame.

Issuers of non-negotiable warehouse receipts include collateral managers. They are becoming increasingly important, with companies like ACE, Cotecna, Control Union, Drum and SGS rolling out collateral management products to serve a growing international market. Notwithstanding the fact that most bankers, borrowers and warehousemen say they find collateral management ?just too expensive? their desire to use the services of collateral management companies is increasing. In the absence of totally secure physical commodity storage facilities and resulting from the risks in moving commodities about, banks are obliged to find other structures for protection against physical risks. The collateral management agreement, or CMA, offered by a number of global firms, offers one such solution.