Dematerialization and Rematerialization in Commodity Markets

The Indian commodity futures market has grown exponentially in the recent times. With the increase in trade volume at the Commodity Exchanges; the need to have a vibrant and efficient settlement system was felt. This led to the concept of dematerialization of warehouse receipts. Demat of warehouse receipt eliminates the difficulties arising out of the use of physical warehouse receipts. Dematerialization refers to the process of conversion of the physical paper (i.e. share certificates, warehouse receipts, etc.) into the electronic balances. In this process the physical paper is destroyed and electronic balance is credited in the demat account owner of the physical document. The concept of demat has been in vogue in the securities market from the year 1996 with the setting up of the first depository i.e. National Securities Depository Limited (NSDL) to remove the difficulties arising out of the use of physical (paper) certificates for settlement of trades on stock exchanges and for improving settlement efficiency.

What is a Warehouse Receipt?

Warehouse receipts are title documents issued by the warehouse to the depositors against commodities deposited in warehouses. These receipts are transferable by endorsement and delivery. Either the original depositor or the holder in due course (transferee) can claim the commodities from the warehouse. According to Sec.32 of the Bombay Warehouse Act, 1959, a receipt issued by a warehouseman shall, unless otherwise specified on the receipt, be transferable by endorsement, and shall entitle its lawful holder to receive the goods specified in it on the same terms and conditions on which the person who originally deposited the goods would have been entitles to receive them. The physical warehouse receipt suffers from the following deficiencies being the paper form of title documents.

• Need for splitting the warehouse receipt in case the depositor has an obligation to transfer only a part of the commodities. A single warehouse receipt is generally issued to the depositor for the goods deposited by him at one time hence he faces this difficulty in case of part transfer.
• Need to physically move the warehouse receipt from one place to another with the risk of theft, mutilation, loss in transit etc. if the transferor and the transferee are at two different locations.
• Risk of fake / forged warehouse receipt with the introduction of dematerialization of warehouse receipt the above deficiencies are taken care of.

Entities involved in the demat process

• Issuer: The issuer is an entity, which floats the physical paper document. It would be a company in case of the share certificate or warehouse in case of warehouse receipt.
• The Registrar and Transfer Agents: It acts on behalf of the issuer as an interface between the issuer and the depository for converting the physical warehouse receipt in the demat form.
• The Depository: The Depository maintains the records of the beneficial owner in its books. Presently there are two depositories in India i.e. National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL)

Types of Demat Account

• Beneficiary Owner Account is used to hold and transact in commodity balances. The depositor is required to quote this account number at the time of depositing commodity in the warehouse. The commodity balances are credited in this type of account. All the investors trading in the commodity markets are required to separately open beneficiary owner account for commodity. The existing demat account for securities cannot be used for the purpose of holding and transacting in the commodity. Unlike the securities demat account, the investors need to open the commodity demat account with both the depositories i.e. NSDL and CDSL. The basic reason behind opening the account in both the depositories is that the Depositories have not yet started Inter-Depository transfer in case of commodities.
• Clearing Member Pool Account is used for the purpose of settlement of delivery obligation. The account is used by the member for giving or receiving delivery of commodity to or from the Clearing House of the Exchange. In short the pay-in and pay-out of the exchange is settled through this account. All the members of the exchange are required to open the CM Pool Account with both the depositories. This cannot be used for holding the commodity.

Process of Demat Commodity

The depositor at the time of deposit of commodity contacts the Exchange approved Quality Certifying Agency (QCA) to get the quality of goods assayed in order to ascertain whether the goods confirms to the quality specification norms of the Exchange. After receipt of the quality certificate from the QCA the depositor is required to fill Commodity Deposit Form (CDF) which contains the details of the quality, quantity, validity dates of both for a commodity, demat account number of the depositor, etc. The depositor is required to ensure that all these details are properly filled in the form to avoid any kind of delays or errors. The depositor submits the CDF, quality certificate and warehouse receipt to the warehouse and receives acknowledgement of the same. The warehouse management then initiates the process of demat credit in co-ordination with the Exchange, Registrar and Transfer Agent and the Depository. The depositor is required to check the holding statement (which can be obtained from his depository participant) after a day or two to see whether the commodity deposited has been credited to his account under proper Commodities Identifier – ICIN.

Concept of International Commodity Identification Number (ICIN)

ICIN refers to International Commodity Identification Number. Commodities that have been dematerialized are identified by its unique code (i.e. ICIN) allotted by depository. ICIN is generated on the uniqueness of the following 4 parameters:

1. Commodity.
2. Warehouse Location.
3. Grade / Fineness of the commodity.
4. Validity date of the commodity.

Change in any of the above parameters will result in the generation of new ICIN. For example, suppose there are four designated Vaults for Gold delivery and 2 qualities of gold are tendered for delivery then a total of 8 ICINs will be generated for Gold. The ICIN descripttion provides the name of the commodity, grade of goods, the unit of measurement and the validity date of the ICIN.

Process of Demat Delivery

If the futures contract on its expiry results into delivery, then the member having delivery obligation is required to give delivery of the commodity to the exchange on or before the respective pay-in date. This is done by transferring commodity from the Clearing Member Pool Account to the Clearing House Account of the Exchange; the member is required to give the delivery instruction to his Depository Participant before the pay-in deadline. On Payout, the exchange credits the commodity to the Buying Member Pool Account.

Rematerialization / Withdrawal / Revalidation of Commodities

The depositor approaches the DP and makes request for withdrawal of commodity in the prescribed form called Remat Request Form (RRF). The acknowledgement copy of RRF is given to the depositor. The depositor will approach the vault / warehouse along with the following documents for withdrawal of commodity.

1. Original copy of acknowledgment issued by DP on which RRN is written
2. Authority letter from the depositor (in case agent)
3. Proof of identification of the agent person.

All agricultural commodities have a shelf life and cannot be stored indefinitely. The “final expiry” of commodity refers to the maximum time period for which the particular commodity has shelf-life. “Validity / Revalidity Duration” refers to the number of times and the corresponding duration for which the quality certification is valid. After the validity date, ICIN is considered to have expired and the same would not be acceptable as good delivery at the exchange.

The depositor has two options after the validity date:

1. The depositor can withdraw the goods from the warehouse.
2. The depositor can go for re-validation of the commodity.

Thus in case of revalidation of commodity, the depositor needs to submit the fresh quality certificate as revalidation form. The relevant quantity will be credited on the new ICIN.

Source: Scribd.com