Risk management within the cannabis industry: Building a framework for the cannabis industry

• DOI: http://doi.org/10.1111/fmii.12104
• Author: Attilio Di Mattia,Karen A. Parker,Robert Whittle,Fatima Shaik,Juan Carlos Cerón Ortega
• Date: 01 February 2019
• Published date: 01 February 2019

DOI: 10.1111/fmii.12104

ORIGINAL ARTICLE

Risk management within the cannabis industry:

Building a framework for the cannabis industry

Karen A. Parker Attilio Di Mattia Fatima Shaik

Juan Carlos Cerón Ortega Robert Whittle

NYU-SternMaster of Science in Risk

ManagementGlobal Degree Program

Correspondence

KarenA. Parker,NYU-Stern Master of Sciencein

RiskManagement Global Degree Program.

Email:karenaparker@yahoo.com

Abstract

Thirty states and the District of Columbia have legalized the use

of cannabis for medicinal and/or recreational use by either formally

or informally de-criminalizing its use. However, cannabis remains a

Schedule 1 drug under the Federal Controlled Substances Act (21

U.S.C.Sections 801 through 812), leaving federal law in conflict with

the laws of over half of the states. As a result, marketparticipants in

legal cannabis businesses face risks due to the industry's unique legal

status within the United States. We examinethe risks and challenges

deemedby the cannabis industry as the top risks facing the industry's

continued future growth and its sustainability.In addition to general

risks inherent in a nascent industry, a legal cannabis business faces

additionalrisks, such as risks in its banking and finance activity, place-

ment of insurance, payment of taxes, and managing its supply chain.

These legal businesses also face true legal risk from the possibility

of being shut down by the federal government and seizure of assets

and product under the CSA. This paper also examines whether the

cannabis industry would benefit from a futures market to mitigate

price risk.

KEYWORDS

banking risk, Cannabis, controlled substances act, funding and

finance risk, insurance risk, legal risk, legal risk, marijuana, market

and pricing risk, supply-chain risk

1INTRODUCTION

The purpose of this paper is to provide an understanding of the legal cannabis industry for medicinal and recreational

use and the associated risks, as a basis to build a risk management framework for a cannabis business.1We have lim-

ited the study to the United States and makeno assumptions as to how or when the illegal market (sometimes referred

c

2019 New YorkUniversity Salomon Center and Wiley Periodicals, Inc.

Financial Markets,Inst. & Inst. 2019;28:3–55. wileyonlinelibrary.com/journal/fmii 3

4PARK ER ET AL.

to as black market cannabis/marijuana in this paper) will conform into a legal market.2As we address herein, a busi-

ness operating within today'senvironment in the United States, and within a non-mature industry such as the cannabis

industry,will face significant challenges in the early stages of the industry's life cycle (Porter, 1985). We recognize that

we cannot identify and discuss all risks that a legal cannabis business would face. However,we have sought to identify

and discuss the top risks faced by the industry and severalmarket participants.

As a result of our research findings, in this paper we examinethe risks and challenges deemed by the cannabis indus-

try as the top risks facing the industry's continued future growth and its sustainability,these include:

•market and pricing risk,

•legal risk, including banking and insurance,

•supply-chain risk, and

•funding and finance risk.

In light of the observations and findings discussed herein, it will be necessary for market participants – primary,

secondary and tertiary – to understand these risks and build robust risk management frameworks to consider and

manage their risks. Some of the risks identified in this paper haveavailable industrial and/or financial risk management

options. A discussion on price mitigation and the potential industrial hedging (through integration) and financial hedg-

ing (through a futures contract) is included to this end. Other risks are more complex and will require the evolutionof

the cannabis industry at large, and changes in federal legislation.

1.1 The plant and its uses

The United Nations Office of Drugs and Crime (“UNODC”) reports that cannabis is widely seen as the most extensively

available drug (legal or illegal) worldwide, in terms of size and geographical spread. Cannabis is grown in 135 member

countries representing approximately 92% of the total global population.3Juxtapose this with the near–global recog-

nition that cannabis has medicinal and therapeutic benefits, and we find that some countries have legalized cannabis

cultivation, sale and use for medical purposes. The medicinal business drives the global momentum for legalization.

All but four of the states in the United States4have enacted some level of legislation allowing for the cultivation, sale

and/or use for medicinal purposes,5and other countries, such as Uruguay,Canada, Spain, The Netherlands, and India,

have passed lawsthat will permit recreational use in the coming years (Kalvapelle, 2017).

Cannabis belongs to the “Cannabaceae” family.It is a genus of the flowering plant and is indigenous to Central Asia

and the Indian subcontinent. Moreover,there are at least three principal species: Cannabis Sativa, Cannabis Indica, and

Cannabis Ruderalis, all three may be treated as subspecies of a single species, namely Cannabis Sativa6. These species

differ from each other by their leavesand plant structure as described in Table1.

Over time and through selective breeding and nature, many strains have developed from these three principal

species. Hybrid strains of the Sativa and Indica species are primarily consumed for their psychological effects and thus

TABL E 1 Principal cannabis species

Species Structure and leave

Cannabis Sativa Tall,thin and wispy

Seven leaves

Cannabis Indica Shorter than Sativa but taller than Ruderalis

Bushier than Sativa but wispier than Ruderalis

Five leaves

Cannabis Ruderalis Bushy and short

Three leaves

PARK ER ET AL.5

primarily used for medicinal and recreational purposes, while hemp, which is primarily Sativa or a Sativa/Ruderalis

hybrid, is used for industrial purposes such as making rope.7

From the flowers of the cannabis plant, approximately100 different compounds called cannabinoids and terpenes

are found in the trichomes (hair-like components) of an unpollinated plant. When consumed, cannabinoids and ter-

penes act on cannabinoid receptors (commonly called CB1 and CB2) in the nervous and immune systems, and produce

psychological effects that are sought by consumers of cannabis. Additionally,terpenes produce the flavor and aroma.

The two most commonly produced compounds are tetrahydrocannabinol (“THC”) and cannabidiol (“CBD”).THC is the

psychoactive compound that gives the user a “high”,while CBD produces the physical effect without the “high”.It is the

relative concentration of terpenes and cannabinoids that are found to target certain medical conditions and provide

relief to patients.

Cannabis has many potential uses with recreational and medicinal purposed products capable of being vaporized,

consumed orally or applied topically as concentratesand infused products. The potential uses of cannabis (as currently

identified) are illustrated in Figure 1.

Examining the compounds and how they interact with the human nervousand immune systems provides an under-

standing the difference between “recreational” and “medicinal” use.

Medical users take cannabis to alleviate the symptoms of a specific medical condition, and medical cannabis tends

to have a higher CBDcontent than recreational cannabis (Jensen, 2015). Figure 2 provides the THC and CBD formula-

tions and the targeted medical conditions and proposed relief provided.

Recreational cannabis users will take cannabis products without medical justification. The recreational user will

seek cannabis with a higher THC content as the consumer wants to experience a “high” rather than treat a medical

condition.

1.2 Industry value chain (value system)

Industries may be classified in a variety of ways but are most often classified according to the three–sector theory

which divides the actors of an industry based on activity,primary, secondary and tertiary (Fisher, 1939).8

FIGURE 1 Potentialuses of cannabis [Color figure can be viewed at wileyonlinelibrary.com]