The safety and certainty of the cédula de produto rural (CPR) has been an unassailable tenant in Brazil’s commodity markets – until a recent cluster of high-profile failures, writes Erika Morphy.

It has been a tedious day for a certain attorney in Sao Paulo. He has spent the morning meticulously double-checking paperwork for a transaction, which until recently could have been considered routine – and utterly safe. Certainly safe enough not to require an attorney to personally assure his client that documents have been duly registered and appropriately endorsed.
But then again, these particular documents support a transaction that has become a staple in Brazil’s agriculture community: the cédula de produto rural, or CPR. Created 14 years ago, CPRs are financial instruments through which a farmer or farming cooperative sells an agriculture crop before harvest. Over the course of these years – particularly the last few – these instruments have assumed a certain aura of inevitability and safety, much like a letter of credit. Indeed CPRs were probably considered even safer than LCs, given how easily a discrepancy can derail payment under an LC.

However a recent series of incidents in which investors did not receive payment under a CPR has shaken the faith in these instruments. Speaking to GTR after a morning of paperwork, the Sao Paulo attorney ruefully notes that almost everyone in the process suffers with this breakdown in faith. “Costs have gone up for investors and farmers as more people feel they have to complete every bit of the process; these transactions are also becoming more time-consuming as well.”

That said it is unlikely that CPRs will ever be abandoned, despite the high-profile failures.
“They have become a critical element for the Brazilian agriculture community especially as the country has a large number of relatively small producers,” the Sao Paulo attorney explains. One byproduct of this, though, is the administrative headache of dealing with a large number of CPRs, he adds – the source of some of the recent failures.
Even without a large number of CPRs to monitor, these instruments can be cumbersome. “But at end of day it gives you an unarguable right to the commodity,” he says.
“When they work – and they almost always do – they work very well.”

The theory
At bottom, these are very simple structures. The farmer receives cash and in exchange promises to deliver the harvest to the investor, usually to a third party-controlled warehouse system.
The farmer – known also as the issuer – usually will provide a guarantee using property as collateral, or insurance will be taken out on the transaction, or some other form of guarantee by a third party, such as Banco do Brasil, will be obtained. Either way, though, there are clear protections for the investor who has handed over cash to the farmer for his crop, which is still at the fertilising or sowing stage. For instance CETIP, a Brazilian clearing system, tracks and reports how much of the crop the farmer has pledged, thus ensuring the farmer has not sold his crop twice or three times.

For this reason, they can often be found embedded in pre-export finance transactions in Brazil, with the CPRs providing an additional element of security.
Other banks may just use CPRs on a select basis. “What we rely on is agriculture and stock pledges which underpin the CPRs,” says Engin Harman, managing director of trade finance at the Landsbanki, London branch. “What we do is take the agri pledge or promissory note directly rather than it underpinning a CPR, which is essentially a tradable instrument. Unless it is a very large deal, in which case we do take a CPR.”
Because the bank primarily operates on a bilateral basis, it is easier for it to take the security directly, he explains.
The beauty of these transactions is that they provide liquidity, both to the farmer as well as the investor. The farmer receives reasonably-priced financing to grow his crop. The investor has acquired an instrument that comes with a ready-made exit strategy; CPRs are easily tradable at commodity exchanges as well as over the counter transactions.

A system tested
More often than not, however, investors and banks have not bothered with the form and formality of a properly-structured CPR.
A clubby community was one reason – the farmers are in a type of relationship where they are indebted to the bank or investor, explains Fabio Liborio, an executive in the collateral management division of Cotecna, a trade inspection, security and certification company. “This is not financing that stretches out across multiple harvests – it is very short term.” So the incentive for fraud is much lower.
Cost is one reason – perhaps the main one – why many CPRs are not ultimately registered or endorsed, says Amy Dulin, an attorney with Hughes Hubbard & Reed in Miami, Florida.

“Each endorsement requires a filing fee and for transactions where there are hundreds of CPRs that can get very expensive.” It is a common market practice in fact, she says, not to register the endorsement. She echoes Liborio in saying that the community is small enough that most of the players are familiar with each other, or at least their reputations.
Few saw these lax practices as a significant risk – until that is, a recent series of incidents in which the CPR structure was tested – and the vulnerabilities in these supposedly secure instruments became clear.  There were different reasons for these failures, but mostly centred around issues of administration, outright fraud and in one case a company that overstretched itself financially.
“Until recently CPRs had a very good and long track record of performance,” Adrian Lewers, underwriter and head of the political contingency group at Beazley, says.

At the heart of most of the failures was the inability for the investor to call or realise on the CPR, usually because it had not been registered properly or appropriately endorsed to the third party beneficiary. Indeed, there is no legal requirement to register or endorse a CPR, but it is an imperfect security if it hasn’t been – an unpleasant lesson some investors and banks learned the hard way this year.
Unless the bank’s rights to the CPR have been endorsed, the trader or first beneficiary is in a position where it can interfere with CPR; it can, for instance, deregister it or allocate the crop to someone else.
“A lot of creditors lost out because they didn’t have standing to claim their rights under CPR,” Dulin says.

Additional security
Not surprisingly, the market has responded by seeking out ways to further secure these instruments. For instance, a CPR can be supplemented with other collateral, such as a mortgage over the physical assets of the farmer or a lien on the land itself.
“I have been advising clients that CPRs can continue to form the basis of the structure but to look for additional collateral and even personal guarantees on the part of the first beneficiary,” the Sao Paulo attorney says.
Personal guarantees are not necessarily the perfect solution either, he adds. Especially in the current economic environment, such guarantees are one bankruptcy away from being meaningless. Also, in some countries, assets can easily be transferred even if they are supporting a transaction.

Few, if anybody, however, expect that CPRs will be completely abandoned because of the security concerns that have been exposed.  Beazley’s Lewers, for instance, has started scrutinising more carefully what measures are taken to perfect the security of the commodity under the CPR. But he has not lost faith in the model. “Whilst there are other, more robust, forms of security – such as CDA/WA, mercantile pledges, mortgages and fiduciary liens – the market will not turn away from CPRs. They just are no longer considered as rock-solid as the banking market once assumed they were – and certainly not bankruptcy remote.”
In today’s market everybody is being a little more cautious, Dulin agrees. “They are definitely considered a useful tool – but one that does have certain limitations.”