09.09.2013

Financing by Pledges of Grain

Introduction

The introduction of grain receipts and the creation of such a system is, objectively speaking, of fundamental importance to the grain market of Kazakhstan, in view of both public and commercial interests.

International experience in countries such as the USA, Canada and other countries, shows that grain receipts are an effective and necessary part of the development of the grain industry; they contribute to the development of the domestic market, in that they ensure effective lending to agricultural producers and improve the financial situation of grain growers.

Introduction

The introduction of grain receipts and the creation of such a system is, objectively speaking, of fundamental importance to the grain market of Kazakhstan, in view of both public and commercial interests.

International experience in countries such as the USA, Canada and other countries, shows that grain receipts are an effective and necessary part of the development of the grain industry; they contribute to the development of the domestic market, in that they ensure effective lending to agricultural producers and improve the financial situation of grain growers.

In view of the above, the legislators of Kazakhstan have drawn up the Law of the Republic of Kazakhstan 'On Grain', dated 19 January 2001, No. 143-II (hereinafter – the 'Grain Law').

In order to implement the Grain Law, the Government of the Republic of Kazakhstan approved the Rules for the Issue, Circulation and Redemption of Grain Receipts, the Requirements for Sample Grain Receipts and Forms of Grain Receipts and the Rules for Production, Acquisition, Storage and Destruction of the Grain Receipt Forms dated 30 November 2011, No. 1395 (hereinafter – 'Rules').

In accordance with the Grain Law, a grain receipt consists of two parts – a warehouse certificate and a pledge certificate, which may be separated from one another, if required.  A grain receipt is considered a non-equity security. 

With the implementation of the Law, the procedure for purchase-and-sale of grain became easier, lending against the pledge of warehouse receipts was increased (grain receipts as a security can be issued as collateral for a loan at a bank, actually under the pledge of grain).  In other words, a grain receipt is a kind of letter of guarantee, which includes information regarding the quantity and characteristics of a certain batch of grain stored at an elevator.

The current law allows a pledge of grain to be constituted either by executing a certificate of endorsement on the pledge or by means of a pledge of grain receipts together with a contract for the pledge of grain receipts.

Under the Rules, for a pledge of grain made by an endorsement of the pledge certificate, the pledge certificate is separate from the warehouse one.

Financing by a pledge of grain is having a positive impact on the development of agriculture in Kazakhstan.

Practice shows that grain as a type of pledge has proved to be a substantial financial instrument that is trustworthy for creditors.

Grain Receipt and Pledge Thereof  

Grain receipt forms are strict reporting forms made in a branch of the National Bank of the Republic of Kazakhstan - Banknote factory, at the request of grain-enterprises.  

For accounting purposes the forms produced by grain receipts contain an MA code, series and number.  The MA code is a registration number of a grain-company assigned by the Ministry of Agriculture of the Republic of Kazakhstan. The series and number of the grain receipt form are assigned by the Banknote Factory of the National Bank of the Republic of Kazakhstan.  The MA code, series and number of the form of grain receipts must be identical in the warehouse and pledge certificates and made typographically.  It is not allowed to assign the acquired forms of grain receipts.

A grain receipt has the following degrees of protection:

  • the front side frame is made by gravure printing method;
  • latent prints;
  • guilloche element;
  • Ben Day screen, 2 types;
  • iris print;
  • numbering;
  • micro text;
  • invisible image;
  • text layout, invisible under infra-red rays;
  • the back side frame is made by offset printing method;
  • anti-copy element;
  • safety paper (stained, without own fluorescence), with iridescent band of 2 colours, contains fluorescent fibers of blue and green colours that appear under ultraviolet rays.

Changing or adding extra degrees of protection for the acquired forms is prohibited.

The advantage of grain receipts is that they simplify the procedure for the transfer of rights to grain.

The pledge of grain stored at a grain enterprise may be made by (i) a certificate of endorsement on the pledge or (ii) by pledging grain receipts and entering into an agreement for the pledge of grain receipts.

In the case of pledges in the form of endorsements on the pledge certificate, that certificate is separate from the warehouse one.

The number of endorsements are not limited, i.e., each new owner of the security may pass it on, meaning that the turnover of grain receipts is quite high.  These securities are considered, as a rule, to possess a high level of reliability.

The endorser is an assignor responsible not only for the validity of the right, but also for exercising it.

A high priority issue is to attain an active turnover of grain receipts, which allows small agricultural producers who do not have floating collateral to solve the problem of obtaining credit in banks.

The significance of this system lies in the fact that a receipt is issued by the elevator for the amount of grain stored in the warehouses, which includes information regarding the quantity and characteristics of the grain.  The current holder of the grain receipt may present the document to the elevator, and will have the right to get a relevant amount of grain products.  After that, the receipt is redeemed and withdrawn from circulation.  Repayment is also made in the case of a partial delivery of grain, and for the remainder of the grain a new grain receipt is issued.  When the receipt is sold to a third party, the grain is sold as well.  A new holder may submit the receipt to elevator to redeem, i.e. to get the grain.

A grain-enterprise repays grain receipts within three days of their delivery of grain or issue a new grain receipt by putting a stamp with the words 'Redeemed' and the record date and type of the repayment.

Below we highlight the main advantages of grain receipts:

- the purchase-and-sale of grain and transfer of grain into pledge in financing credit institutions is easier;

- a grain receipt serves as an underlying asset for derivative financial instruments, the circulation of which is insurance against losses when prices fall and profiting from price fluctuations of the underlying asset in the future;

- the owner insures himself against losses associated with a fall in prices in the future by transactions with derivative instruments, such as forwards, options and futures, and the buyer of grain receipts can also gain benefit in increasing the price of grain receipts in the future.

A cereal company is obliged to submit to a local executive body the card with the full names of persons authorised to sign the grain receipts, specimens of their signatures, and sample seal put on the grain receipts.

Inconsistency of signature or seal on a grain receipt with the signature and seal indicated in the card presented to the local executive body can be a basis for invalidating the grain receipts.

The holder of the warehouse certificate has the right to dispose of the grain stored with a cereal company, but is not entitled to claim the delivery of grain from the cereal enterprise until the repayment of a debt under the pledge certificate in accordance with the laws of the Republic of Kazakhstan.

The holder of a pledge certificate has the right to:

1) require from a person the separation the pledge certificate from the warehouse one to fulfil obligation certified by the pledge certificate and pay interest thereon;

2) transfer the pledge certificate and associated rights to third parties.

In case of the failure to -perform or improper performance of the obligation certified by the pledge certificate, the holder thereof is entitled to levy an execution on the grain specified in the pledge certificate.

If at the time of execution the grain was claimed from cereal enterprise by the holder of warehouse certificate, and the cereal enterprise was provided with a document certifying the performance of the secured obligations and the payment of interest on it, then the holder of pledge certificate must return the certificate for repayment.

The holder of a pledge certificate, if his claim secured by the pledge is not satisfied within the specified period, has the right to levy execution on the pledge to satisfy his claims by an independent extra-court sale.

Please note that banks face a number of risks with the financing by grain pledge, including:

  1. damage to the elevator’s property and, thus, deterioration of grain;
  2. theft of grain;
  3. issue of the grain receipts for non-existent volume of grain;
  4. the faking of grain receipts.

To eliminate the risks mentioned in points 1 and 2 above, the 'Fund of Guarantee of the Fulfilment of Obligations under Grain Receipts' was established. This was done in view of the provisions of the agro-food program for 2003-2005. The task of the fund is to eliminate the risk of non-payment of receipts to elevators, saving it as a security.

The main objective of the fund is to protect the interests of holders of warehouse receipts from the failure of cereal companies to perform obligations under the grain receipts issued by them.  According to the Rules on the Establishment, Operation and Liquidation of Funds of Guarantee of the Fulfilment of Obligations under Grain Receipts and the Participation of Cereal Enterprises in the System of Guaranteeing the Fulfilment of Obligations by Grain Receipts, dated 27 April 2004, No. 470, certain requirements must be met in order to become a member.

Thus, banks were able to lend to owners of grain receipts providing there were guarantees of grain safety at elevators or refunds in the absence of grain.  So, the guarantor's functions were assumed by the above-mentioned fund.

Cereal enterprises that are not members of the guarantee system are required to insure their liability to the holders of warehouse receipts/parts of receipts.  Insurance, in case of the loss or deterioration of grain received for storage, ensures that each holder of grain receipts is paid an insurance premium.  However, the insurance payment can only cover up to eighty percent of the market value of the lost or degraded grain, without any franchise conditions. 

However, this insurance does not protect the holder's interests one hundred percent.  Usually, the insurance agreement is signed for one year.  As practice shows, some cereal enterprises do not offer insurance.  In this regard, there are situations where the grain is provided as collateral for more than one year and the liability of cereal enterprise is not insured, and in case of loss or deterioration of the grain at the time of claiming it, the pledge holder faces a risk that funds will not be repaid.

According to the report regarding the draft Law of the Republic of Kazakhstan 'On Making Amendments to Some Legislative Acts of the Republic of Kazakhstan on Regulation of the Grain Market', dated 29 December 2012, No. 1744, the risks referred to in items 3 and 4 may be reduced, in particular, to prevent violations of the law on grain, the draft law contains provisions which establish more regular inspections of cereal enterprises. Under the current legislation, scheduled inspections of cereal enterprises are carried out every six months in case of a high degree of risk.  Six-month intervals between scheduled inspections allow violation of grain laws, in that they allows cereal enterprises to recover the amount of grain or put in order the accounting records.

The adoption and implementation of the draft law would achieve the following:

1. Preventing violations of the grain legislation by cereal enterprises.

2. Ensuring the protection of interests of agricultural entities and holders of warehouse receipts.

3. Transparency in the process of transferring grain receipts and in the operational analysis of grain movement within the country.

4. Reduction of costs in transactions, elimination of fakes and reduction of time required to register grain receipts.

We would also like to describe a solution to the problem from the perspective of international experience.  The Russian Federation, for instance, in order to further develop grain market instruments, prepared a draft law, which involves the issue of warehouse certificates for grain by accredited warehouses and the establishment of a self-regulating organisation of these warehouses. The document allows the implementation of specialised securities for the grain industry:  double and simple warehouse certificates for grain.  These certificates allow agricultural producers to attract credit from banks.

According to experts, the grain market will have clear rules of work, and farmers will be able to use warehouse certificates as collateral for bank financing.  Using the public warehouse system and warehouse certificates will increase the overall transparency and reliability of grain storage, so that lenders will feel more comfortable.  The draft law also includes a procedure to levy execution on pledged goods represented by the warehouse certificate, thus bringing it closer to the international practice.

Conclusion 

Our legislation in the area of grain is in the process of change.  The Government intends to introduce a system of electronic grain receipts.  According to the Vice Minister of Agriculture of the Republic of Kazakhstan - Mr M.T. Umiryayev, it may take about three to four years.

The Ministry of Agriculture has developed amendments to the legislation on the regulation of the grain market.

One of the goals of the draft law is to improve the system of electronic grain receipts. An institute of grain receipts was introduced in Kazakhstan in 2001 and generally proved to be efficient in practice due to an adequate legal framework, said the Vice Minister.

"A fundamental issue is to achieve an active turnover of grain receipts, which allows small agricultural producers who do not have floating collateral to solve the problem of obtaining credit in banks. However, the introduction of grain receipts in a documentary form is a significant barrier to the development of the electronic trading of grain,"- said Mr Umiryayev.

Thus, after the implementation of the Grain Law the situation regarding financing by pledge of grain receipts has been greatly improved.  The way the above mentioned problems were resolved using accumulated Kazakhstani and international experience has had a positive effect on this market segment.  As a proof of this there are financial programs developed by the state (for example, Agroobiznes - 2020) and the products developed by the second-tier banks for agricultural production.

 

 

Dina Daumova, Lawyer

Finance and Securities Department

Tel.: +7 (727) 2 445-777
Fax: +7 (727) 2 445-776
finance_securities@gratanet.com

 


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