Capital market instruments for agriculture - What can we learn from Brazil?

Capital market instruments for agriculture – what can we learn from Brazil?

Lamon Rutten

CTA Revolutionising finance for agri-value chains

Nairobi, 14-18 July 2014

www.fin4ag.org

Start of the Brazilian programme

• Up to the early 1990s, Brazil’s agri-finance was government driven: Banco do Brasil was a large financier, and since 1965, all banks in the country were obliged to allocate 25 per cent of their demand deposits to the agricultural sector, mostly to be lent at a fixed, low interest rate

• But the State had to reduce its involvement in agricultural finance and marketing; at the same time, agriculture continued growing

• In the early 1990s, the private sector developed prepaid forward contracts as a financing tool, but these carried high transaction costs and were difficult to enforce.

• In 1994, the government strengthened the regulatory framework for such new financing mechanisms by introducing the Cédula de Produto Rural (CPR, literally “rural product note”)

CPRs are bonds that can only be issued by farmers and farmers’ associations, including cooperatives,

in which they pledge an agreed amount of crops (including in semi-processed form, such as ethanol) or cattle, in return for financing.

CPRs have since become the underlying for many other forms of agri-financing.

An important reason for CPRs’ popularity is their strong legal status:•rights are enforceable through out-of-court arbitration procedures; •The seller is barred from using force majeure or “Acts of God” as an excuse for defaulting on his obligations;•they benefit of priority rights – the commodities mentioned in the bonds cannot be seized by third party creditors, even in the case of bankruptcy of the issuer.

CPRs can also be issued electronically

The basic form of CPR - 1994

FarmerBuyer/

investor FarmerBuyer/

investorWare-house

Physical CPRInitial date Harvest/delivery time

Delivery of crop or cattle into pre-agreed warehouse/ stock yard

Delivery of warehouse/ stock yard receipt

Payment

Sale of a bond committing delivery of a set amount of crops, processed products or cattle of

a stipulated quality at an agreed delivery location. Set

discount/premium if delivery quality differs from the agreed one.

CPR forms introduced in 2001

FarmerInvestor/ input cy. Farmer

Investor/ input cy.

FarmerBuyer/

investor FarmerBuyer/

investor

Financial CPR

CPR indexed to futures market

Farmer issues a Financial

CPR, based on the expected value of his future production

Payment

Payment

Market

Sale

Payment of the CPR, at

issue value plus interest

Farmer issues an indexed

CPR, specifying a quantity and a reference price

Paymentof quantity multiplied by the reference price at the

eve of settlement

Physical CPRs are mostly used between buyers and sellers.

Financial CPRs can be issued to a bank or other credit provider which has already promised to finance the farmer (for example, an input supplier wiling to sell on credit);

or it can be auctioned off to the highest bidder through the electronic network of the commodity exchange (the latter would generally require the farmer having received an aval/guarantee from a reputable bank or

cover from an insurance company on his CPR).

In order to be publicly negotiated (i.e., to be considered as financial assets), CPRs must be registered in the System of Registration and Financial Settlement of Assets, as managed by the Central Bank of Brazil.

Currently, two registries are approved by the Central Bank, the Bolsa Brasileira de Mercadorias (BBM, part of the country’s futures exchange, BM&F), and CETIP (the Settlement and Custody Chamber) – CETIP is by far the largest registry for rural bonds. Once issued, CPRs must be held in custody in one of the 50+ financial institutions authorized by the regulatory authority for capital markets to provide custody services for securities.

Once CPRs are in a Central Bank- approved registry they can be used for many purposes:

• They can be traded on the commodity exchange; •they can be used to meet delivery obligations on a futures position; •they can be traded over-the-counter; •they can be auctioned off through Banco do Brasil’s e-auctioning system (cost: 0.75%); •they can be used to meet margin requirements on BM&F; •and they can be used as underlying for more complex financial instrument.

The standard form of using CPRs in a financing transaction

The cattle have to be identified by numbered rings, with “SISBOV” numbers registered in the Ministry of Agriculture and the vaccination control services. All of the animals’ SISBOV numbers are specifically mentioned in the CPR.

Building on CPRs – the post-2004 alphabet soup

Acronym Name Underlying collateral IssuersPre-harvestCPR Cédula de produto

ruralCrops, cattle, to be produced in future

Farmers, cooperatives

LCA Letra de crédito do agronegócio

Loans backed by agribusiness credit rights

Banks

CDCA Certificado de direitos creditórios do agronegócio

CPRs Agri-businesses

Certificado de recebíveis do agronegócio

Receivables (linked to CPRs and CDCAs)

Securitization companies

EPA Export prepayment agreement

Commodities (agri or non-agri)

Commodity producers

Post-harvest

Certificado do depósito agropecuário

Goods in warehouse Warehouses

WA Warrant agropecuário Goods in warehouse Warehouses

Using CDCAs to finance a sugar milling operation

Using CRAs to finance multiple suppliers

Use for post-harvest finance

There is a strong secondary market for CPRs

But copying the Brazilian system is not easy: you need a strong support system

Questions?

www.fin4ag.org

Thank you for joining us in Nairobi!