Warehouse receipts have been around for hundreds of years, being incorporated into English law in the late 19th century. Warehouse receipts are used extensively in the commodities sector, alongside other logistics documents such as bills of lading, to help provide evidence of ownership, possession and other legal rights of goods stored in warehouses, vaults, etc.
Sometimes called warrants or warehouse warrants, (which can have a different legal meaning, depending on the purpose, issuer and jurisdiction), these documents have remained stubbornly paper-based, resulting in a slow-moving, costly and inefficient system. There are a variety of reasons for this, not least the questions of the legal status of non-paper (i.e. electronic) records of deposit.
However, that situation is changing. Legal opinion is beginning to form that electronic or digital records might be legally acceptable. Given the rise of blockchain/DLT and the number of major organisations investing in digital initiatives, it will surely only be a matter of time before this becomes fact.
This is not the whole story. There are plenty of other issues above a solid legal basis which are required to create trusted digital documents of title/possession.
So what are the key elements required to build trust in digital commodities? Here we set out some thoughts based on our experience to date.
Mutual trust and co-dependence
For a system of warehouse receipts to work effectively, there needs to be network of like-minded (or, at least, goal-sharing) and equally trusting participants. Many historic exchanges started as mutual gatherings of organisations looking to provide a venue where trading can take place providing the easiest of access. For example, the London Metal Exchange only de-mutualised when Hong Kong Exchange Group bought it in 2012.
Of course, this isn’t something that technology can necessarily deliver, but the right technology approach – for example with easy, low-cost access, and high transparency built in – has been shown to help build trust between participants.
A well-ordered and controlled warehousing network
A key issue with commodities and storage, in particular, is the warehouse network. The most effective systems we have seen involve independently owned and operated warehouses which must comply with a series of rules and standards and be registered and approved by the market operator.
An inspection regime, insurance requirements, rigorous operating procedures and security requirements all must be complied with. It also adds considerably to the trust levels when the warehouse companies stand to benefit from being part of the network, as they then have an incentive to follow the rules and become a more attractive service provider.Trusted technology platform
To be digital, obviously there must be a trusted software platform, provided by a known and trusted company with a proven track record in the relevant technology, not simply an online website where commodities storage can be registered.
- Such a platform needs to have several key elements over and above basic features:
- Use of a platform should be by named, approved individuals not general company users
- Each transaction should involve multiple party authentication and approval stages. In a traditional sense, this provides similar assurance to that of so-called consensus algorithms that blockchain and DLT rely upon
- Everything that happens on the platform must be fully logged to a secure audit trail
- The platform should be open to all participants in the value chain, securely and transparently
- It adds to the trust level if participants are notified in real-time when key events happen
- It may sound obvious, but data should be presented in real-time rather than as static reports (e.g. as PDFs)
Advances in technology
As all aspects of our daily lives move towards digital, the challenges related to linking physical commodities to the digital financial world remain a real issue. Advances in technologies like the Internet of Things can enable additional trust layers to be added, which will undoubtedly help to increase the ‘trust quotient’.
As an example, if commodity warehouses and storage facilities can use monitoring technology which is directly linked to digital warehouse receipts or warrants, and the data is made securely accessible to owners and financers, one can only imagine the potential reduction in risk and corresponding increase in trust for transacting parties based on the assured security of the underlying goods.
Ultimately, there is no simple answer to creating the required level of trust and therefore liquidity in digitalising commodities. The solution lies in exploring every aspect of what modern technology can provide and building a multi-layer approach which relies on mutual value and a robust governance framework. Understanding best practice and employing experienced professionals shortens time-to-success considerably. One could draw some parallels between the use of pervasive paper in commodities and the apprehensive adoption of cloud computing by many large financial companies. Not that long ago, the finance sector was wary of moving away from ‘physical’ computing, as they couldn’t ‘see’ or ‘touch’ the computers in the cloud. Perhaps the physical paper in commodities could go the same way…