New moves in regulating warehouses

by Anirudh Burman and Iravati Damle.

Warehousing is an important aspect of supply chains. Good warehousing has direct advantages in terms of storage of value, facilitating pledge financing, reduction in wastage, and reducing price shocks by allowing market participants to anticipate future demand and plan for the same. Warehousing has to be trustworthy for these benefits to accrue. Market participants have to be confident that the information provided in warehouse receipts (proof of deposit of a commodity) is accurate at all times. The warehousing sector in India does not reflect these attributes at present. Government regulation can correct some of these inefficiencies.

The warehousing sector in India is unorganised and fragmented (link). The organised segment is dominated by the public sector undertakings such as the Central Warehousing Corporation (CWC) and State Warehousing Corporations (SWC). Over the past decade, private firms have ventured into the business of warehouse services (warehouse service providers or "WSPs"). A large number of small and state level entities dominate the private warehousing segment (link). Under the current constitutional framework, state governments make legislation to regulate licensing of warehouses(For example, West Bengal Warehousing Act, Punjab Warehousing Act, Karnataka Warehousing Act). States across the country have different licensing norms; with different standards (See page 16 of a note on the proposed framework for registration of warehouses for comparison of State warehousing laws of Punjab, West Bengal and Karnataka)


This has resulted in the following problems in the warehousing sector:

• Lack of national standards and uneven levels of enforcement action on offences committed by Warehouse Service Providers (WSP).
• The absence of an integrated information system prevents high quality warehouse service providers from sharing information with potential customers. Therefore, they are unable to differentiate their services from the other players in the market and charge higher rents. As a result, the sector is currently in a low level equilibrium. This will ultimately hamper the growth of the warehousing market, with high-quality warehousing services withdrawing.

The market has started creating its own systems for dealing with inefficiencies. For instance: Banks undertake lending activities against warehouse receipts through Collateral Management Companies (CMC). These banks pay a premium to the collateral managers to insure themselves against the risks of bad warehousing. The collateral managers provide a range of services, including:

• Locating good warehousing facilities;
• Taking delivery of pledged commodities and/ or verifying their quantity and quality;
• Ensure the physical security and quality of the stock for the bank;

Establishment of WDRA

In 2006, the government passed the Warehousing Development Regulation Act, to make provisions for the development and regulation of warehouses, negotiability of warehouse receipts, establishment of a Warehousing Development and Regulatory Authority and for matters connected therewith or incidental thereto. The Act allows warehouses registered with the WDRA to issue Negotiable warehouse receipts (NWR), which are backed by a legal sanction. The WDR Act and accompanying rules and regulations stated registration requirements with the objective of keeping a check on the warehouse service provider. However, it has failed to receive the expected response from the market and bridge the information gap, with the use of NWRs being low.

How do we solve the problem?

WDRA was established to be a national regulator that would build trust and credibility in the instrument of warehouse receipts by ensuring warehouse operators are competent, follow the required processes correctly, and adhere to minimum standards set by WDRA. This is intended to add comfort to those trading in NWRs. As an agent of the State, WDRA has to do so by following the rule of law. Regulations drafted by it must follow a procedure where all stakeholders are informed of the rationale of the proposed regulatory system, the problems that the regulation proposes to solve, and the proposed method of solving these problems.

Lessons from FSLRC for WDRA

The recommendations of the Financial Sector Legislative Reforms Commission (FSLRC) are important in this regard (link).  The Financial Sector Legislative Reforms Commission drafted the Indian Financial Code (IFC) which makes substantial recommendations regarding the procedure that financial regulators must follow while making regulations (Report of FSLRC, Vol 2). By Section 52 of the IFC, if a financial regulator proposes to make any regulations:

• it must publish a draft of the proposed regulations
• this must be accompanied by a statement listing the objectives of the regulations, the problem that the regulations seek to address, the underlying principles, expected outcome, cost benefit analysis, process of making representations.
• it must list the reasons for preference of one principle over another.
• it must publish the representations received, take them into consideration and also state its response to the representations received.
• if the final regulations differ from the proposed regulations, it must list the details and reasons for the difference and also undertake a cost benefit analysis of the differing provisions.

NIPFP has supported WDRA in drafting two concept notes for making draft regulations pertaining to the registration and grading of warehouses. WDRA has solicited public comments on these notes:

• Cover Note: (link)
• Note 1, pertaining to the proposed regulatory framework for registering warehouses by WDRA: (link)
• Note 2, pertaining to the creation of a grading system for warehouses and the regulation of entities who may be allowed to grade warehouses: (link)

Feedback on the two notes may be sent latest by 20th July, 2015 to the Director (Tech.), WDRA at dirtech.wdra@nic.in or may also be sent to the Director (Tech.), WDRA, 4/1, Siri Institutional Area, August Kranti Marg, Hauz Khas, New Delhi 110016.

This style of rational, consultative and transparent regulation-making is, as yet, unusual in India.

Conclusion

The field of warehousing suffers from uneven regulation and the absence of national standards. Stakeholders argue that registration requirements with WDRA do not provide market relevant information about the credibility of the WSP/warehouses. The costs of registration outweigh the benefits. This is hampering the growth of the warehousing market in the country. The first note envisions a redesign of the registration process to establish minimum standards and provide quality assurance to market participants. The second note makes the case for WDRA to facilitate the process of generating credible information about registered entities through a system of grading warehouses and WSPs, after registration. While better registration norms will establish minimum standards, grading will ensure that the market gets information about the performance of the warehouse/WSP post registration. These interventions can enable WDRA to efficiently solve the market failures.