Norton Rose Fulbright is to advise the International Finance Corporation (IFC) and the Food and Agriculture Organization of the United Nations (FAO) on a feasibility study relating to the introduction of pre harvest crop receipts in Africa using Zambia and Uganda as pilot jurisdictions.
Farmer fragmentation and the introduction of crop receipts
The fragmentation of African (and other farmers) is well documented. Various reasons account for this, not least the inability of farmers to source financing particularly at pre harvest time when they desperately require financing to purchase inputs such as seeds, fertilizer, machinery and so forth.
Crop receipts are a pre-harvest financing instrument issued by producers that are collateralised against the crops under production. They are promissory notes to deliver a certain quality and quality of agricultural produce at a defined future date. By purchasing the crop receipt, the buyer pre-finances the production of the crop and is repaid at the delivery or expiry date of the receipt. Crop receipts can be issued by farmers, cooperatives or agro-processors and purchased by input suppliers, offtakers, banks or financial investors.
Crop receipts can have three main functions:
- They can serve as a collateral substitute complementing or substituting other forms of collateral used by agricultural producers to obtain finance,
- They can allow new actors to finance agricultural production (e.g. financial investors/capital markets, agribusiness)
- They can enhance the liquidity of pre-harvest financiers through securitization and secondary markets, based on the crop receipt as the underlying.
- There are two basic types of crop receipts:
- Physical crop receipt: A promissory note by a producer to deliver a specified quantity of commodity, of specified quality, at a specified location, on a given date.
- Financial crop receipt: A promissory note by a producer to deliver the cash equivalent value of a specified quantity of commodity, of specified quality, on a given date – two variants:
- Fixed price variant: the repayment amount is set in advance;
- Indexed price variant: the repayment amount is indexed against a commodity price that prevails on the specified date.
Brazil and the revolution of agrifinancing using crop receipts
To date crop receipts have been used only in a handful of jurisdictions as a mainstream way of raising agri financing. The main success story has been in Brazil, although recently FAO, IFC, and European Bank for Reconstruction and Development have worked to replicate the instrument in Eastern Europe (notably the Ukraine and Serbia).
In Brazil, the crop receipt was introduced in 1994, driven by a leading public sector bank, Banco do Brazil, and has been scaled to annual sums in the USD billions. Commodities that are financed in this manner include traditional high value export commodities such as soya bean, coffee, cotton, sugar and livestock, but also lower value commodities including rice, beans, milk, potato and coconut, as well as specialist commodities including various forms of timber.
Crop receipt issuers tend to be mainly medium-to-large commercial farmers and producer cooperatives. Due to the nature of the transaction costs, they do not tend to be issued directly by smallholder farmers but could be issued on their behalf by aggregators such as cooperatives.
Crop receipts are registered in one of two collateral registries; enforced through fast track judicial processes; offered by producers for auction through the customised platforms of the Banco do Brazil, or through the general commodity exchange, the Brazilian Commodity Exchange (BMM); and packaged as securities issued to capital market investors under rating from the credit ratings agencies, such as Moody’s.
The successful introduction of crop receipts and their acceptance in the market has been supported by several key factors including:
- Customised legal framework – legislation that uphold the rights and obligations of the parties, especially in the event of nonperformance and allows for speedy enforcement.
- Strong support by Banco do Brazil, the largest commercial bank with majority shareholding of the Government of Brazil – through and auction floor supported by partial guarantee mechanisms;
- Enabling institutional and market framework - including wellorganised value chains, commodity exchanges for price determination and hedging and two centralised collateral registries at the commodity exchanges;
- Monitoring mechanisms – agricultural service providers, often divisions of existing organisations such as input or equipment suppliers, financiers, collateral managers or NGOs, provide monitoring services for the crops in the ground;
- Negotiability of the instrument so as to be traded from party to party on a commodity exchange, enabling agribusiness or financiers to tailor and manage exposures;
- Incentives, such as exemptions from the financial transaction tax and access to some subsidised credit lines
- Securitization instruments that enable agribusiness to manage their liquidity based on the crop receipts that have been issued to them – i.e. a financing channel for agribusiness that enables them to obtain more funding that can be passed on to farmers/cooperatives.
The crop receipt in Brazil is not the only source of finance for producers – it complements an array of other financing instruments, some with similar features as well as more conventional ones. Therefore, the crop receipt is not seen as the panacea for pre-harvest finance, but rather one additional choice that producers have to increase, tailor or diversify their financing options.
How can crop receipts help finance African agriculture?
Given its success in Brazil the IFC, FAO together with NRF has embarked on an exciting project to see whether similar forms of financing could be introduced in the African environment. Crop receipts could help farmers to access additional, timely sources of finance for inputs, with repayment terms shaped according to the needs of the agricultural cycle.
In particular, crop receipts can help to address the pervasive collateral constraints in the rural economy by providing financiers with an additional security instrument which can be readily evaluated, perfected and enforced, and can provide them greater comfort to finance the sector.
They also allow agricultural producers and value chain actors to tap into diverse sources of finance beyond banks, including capital markets through financial and commodity exchanges and “over the counter”. Financial investors might be interested in crop receipts, or securities issued on the back of crop receipts, to provide new alternatives for portfolio diversification.
From the perspective of agribusiness and financiers, the legal protections, monitoring mechanisms and liquidity management instruments associated with the regime for crop receipts provide a secure means of more efficiently integrating value chains and financing the agricultural sector.
At present, the pre-harvest financing that exists in Africa tends to be unsecured based on value chain relationships, bringing higher costs and risks – performance risk, price risk, risk of side-selling – which reduce or deter the potential flow of finance to the sector, and in particular the smaller players which may not otherwise have access to finance through the mainstream banking channels.
Crop receipts could help to mitigate or overcome these challenges, especially if accompanied by an enabling legal, regulatory and institutional framework. Crop receipts are a more standardised legal instrument linking commodity and financial markets that can be used in various ways, including (i) for barter transactions between value chain players substituting prepaid forward contracts, (ii) as an alternative to pre-harvest credit for banks allowing for rapid out of court settlement, (iii) as additional collateral backing credit contracts, (iv) as basis for securitisation. This instrument would constitute an alternative to bank loans and to unsecured preharvest financing that typically takes place through contract farming today, thereby enhancing the availability of pre-harvest financing and/or reducing its costs.
How is the Africa Crop Receipts Initiative working to implement crop receipts in Africa?
The Africa Crop Receipts Initiative is being developed in two phases:
- Background research on key success factors and enabling conditions;
- Pre-feasibility studies in two sub- Saharan African countries (Zambia and Uganda);
Subject to the outcome of these assessments, IFC may be interested in supporting the introduction of crop receipts on a pilot basis as well as potential follow-up activities.
Background research has so far focused on identifying the preconditions for introducing crop receipts on a continental level in sub-Saharan Africa, taking into account key lessons from Brazil and Eastern Europe, but also bearing in mind relevant differences in the respective contexts, and in particular by defining the success factors that can drive scalability and inclusiveness.
There are significant differences between the Brazilian agri economy and those that exist in Africa. This is well understood by the parties involved in this project. For this reason initially the project will centre around creating an exploratory framework to assess first whether there is need and opportunity for crop receipts in the African context, and if so, secondly, how crop receipts can be adapted and customised to work in African jurisdictions.