Warehouses

In the Indian context, warehouses are necessary for the commodity sector and commodity future trading especially for farmers because agricultural commodities constitute a major segment of the Indian economy. Warehousing forms the basic platform of delivery based trading in commodity futures. Warehouses play a significant and decisive role in the proper and efficient functioning of commodity futures trading, as most of trades are settled with delivery. That is, if the seller chooses to handover commodity instead of the difference in cash, the buyer must take physical delivery of the underlying asset.

Commodity futures are contracts where commodities are traded in future prices. The system of trading commodity futures is very simple and easy. Let us assume that a person buys commodity futures for $1000. After some time, the value of the commodity futures increases. As a result, the buyer of the commodity futures will gain because he can now sell off the contract for an amount higher than the amount for which he purchased. This type of contract can also be referred to as a forward contract where commodities are purchased at present but the commodities are delivered after a certain period of time. Here the commodities are not actually traded. The commodities are stored in a warehouse and they are taken out from the warehouse only after the expiry of the period mentioned in the commodity futures.

The warehouse operator holds the stored commodity by way of safe custody and is legally liable to make good any value lost through theft or damage by fire and other catastrophes, but has no legal or beneficial interest in it.

When the commodity sold in Futures market is taken to the warehouse, the client receives a legal document from the warehouse known as warehouse receipt.

Warehouse receipts: WR are documents issued by warehouse operators as evidence that specified commodities of stated quantity and quality have been deposited at particular locations by named depositors. The depositor may be a producer, farmer group, trader, exporter, or indeed any individual or body cooporates.

NSDL, the first depository in the country was established in the year 1996 to remove the difficulties arising out of use of physical (paper) certificates for settlement of trades on stock exchanges and improving settlement efficiency. The depository system has successfully met its objectives. On the basis of the success of demat, rolling settlements were introduced and today, India is one among the few countries that have T + 2 rolling settlement system.

Drawing lessons from the depository system for securities, NSDL and national level multi-commodity exchanges have worked out a scheme to extend depository services for settling trades in commodity futures.

With the increase in activity in the commodities futures market and establishment of national level screen-based multi-commodities exchanges, need for an efficient settlement system in that market is felt. Broadly, a commodity futures contract may be settled either by cash or by delivery of commodity depending upon the terms of the trade, demand of the buyer and rules of the exchange. If the trade is expected to be settled by way of delivery of commodity, the clearinghouse of the commodity exchange will receive warehouse receipts from the seller instead of actual commodities and pass such warehouse receipts over to the buyer. In case of national commodity exchanges, buyers and sellers operate from different parts of the country and if warehouse receipts are in physical form, the warehouse receipts have to be delivered across the country from the seller to the buyer, which could lead to systemic inefficiencies.

Warehouse receipts are title documents issued by warehouses to depositors against the commodities deposited in the warehouses. These documents are transferred by endorsement and delivery. Either the original depositor or the holder in due course (transferee) can claim the commodities from the warehouse. Warehouse receipts in physical form suffer all the disadvantages of the paper form of title documents.

Some of these limitations are as follows:

• Need for splitting the warehouse receipt in case the depositor has an obligation to transfer only a part of the commodities;
• Need to move the warehouse receipt from one place to another with risk of theft/mutilation, etc. if the transferor and transferee are at two different locations.
• Risk of forgery.