Commodity Exchanges Best Practices
Commodity Exchanges Best Practices
Commodity Exchanges Best Practices
There continues to be much debate about commodity exchanges in Africa, not only regarding
their need, but also their ability to make a difference in the markets in which they operate. Whilst
this debate continues, a number of initiatives have been started, some of which have been more
successful than others.
From the outset, it is crucial to understand the need for certain fundamentals to be existing to
enhance the chances of a new commodity exchange succeeding. These include:
A CLEAR OBJECTIVE
The need to know what you want to set up and why;
This is necessary for potential participants and for the general view (inside & outside);
A business plan (prospectus) is a good way to start; and
For a futures exchange the need to provide a price risk management facility.
The trading system must be requirement driven, robust, flexible and allow for growth in
all aspects;
The clearing system must be reliable and efficient and ensure confidence in the trading
arena.
A commodity exchange needs CLEAR RULES and CONSISTENT SURVEILLANCE to maintain INTEGRITY.
Primary role of government is regulating the exchange; (where there is the capacity)
An exchange requires clear and balanced rules that are consistently applied;
An exchange requires ongoing surveillance;
Integrity is paramount;
Act decisively.
A commodity exchange needs TO STAY IN TOUCH, LEARN FROM ITS MISTAKES, BE ADAPTABLE and
BE RELEVANT.
An exchange serves the market and must constantly re-evaluate whether it is in touch
with reality;
Members: 450 Members, 7800 clients, 12% farmer cooperative unions-2.4 million small
farmers reached
Trading: 2010-11: 504,000 tons of commodities (coffee, sesame seed, pea beans, maize);
US$ 1.2 billion trade value; 109,500 transactions
Warehousing: 17 delivery sites; 4.7 million bags/year graded, handled, stored, and
delivered, 300,000 tons storage capacity
Clearing: 8 partner banks; 2010-11: 14,228 Pay-in transactions from buyers and 25,796
Pay-out transactions to sellers/year, settled by 11 am next day
Market data: Real and discrete time, push and pull technology:
Prices transmitted in 2 seconds to 31 rural ticker boards
Website -2000 hits/day, 2nd most visited after SAFEX);
IVR (call-in price update): 61,000 call-ins/day
SMS (mobile push out): 156,000 subscriber
Whilst there is evidence that the ECX has been successful in terms of the volumes and values
traded, this needs to be put into perspective as the Government of Ethiopia has legislated that all
coffee and sesame trades have to be conducted across the exchange floor, the only exception
being producers who can sell into the local or export markets directly.
The following quotes were received from market participants over the last six to twelve months:
1. The ECX would have collapsed if the Government had not legislated that coffee MUST be
traded across the Ethiopian Commodity Exchange Floor.
2. It is an absolute disaster, which has undermined the coffee trade in Ethiopia and impacted
negatively on exports.
3. Under the auction system, the auction floor had samples ready for inspection by 1pm. Buyers,
exporters and others could view samples and place bids on them. The trucks with the whole
parcel were waiting outside, so there was no double handling and the commodity was kept in
a better condition as a result. By 7pm, buyers could have twelve or more trucks delivering the
commodity to their warehouses for processing. Any dispute as to weight or quality was sorted
out by the auction floor, even after delivery.
4. Farmers have not and do not benefit from the new marketing system, despite claims to the
contrary.
5. The coffee is owned by the traders, who buy it from the washing stations (no change from the
previous system), who now HAVE to sell it across the ECX.
6. The coffee is sold sight unseen and often both the quality and quantity paid for differs from
what is subsequently collected.
7. Collection is from one of three ECX run warehouses in Addis Ababa and can take up to four
days to collect due to the number of trucks in the queue.
8. A flat 2% commission is charged by ECX for every contract.
9. The general feeling is that rather than enhance transparency, the ECX has made the coffee
market much less transparent.
10. The price has increased on ECX, not due to demand or the fact that farmers are getting more,
but due to the system. The Exchange has set a price band for coffee to be traded, which does
not take into account that 20% of the weight of the bean is in the parchment), thus making the
coffee much more expensive. The levels set are also at the top end of the range for coffee,
which usually only occur when there are shortages elsewhere.
11. The lack of traceability has also impacted on exports as buyers look for coffee from a
particular area, or even specific farms. Owing to the fact that the coffee sold on ECX is more
of a generic nature, this is not possible any longer.
12. Whilst discussing the ECX with a cooperative representative in Livingstone earlier this year,
the indication was that they do not use the Exchange other than for the lowest grades as they
are able to achieve higher prices by selling directly into niche markets.
13. Earlier this month, we met a trader who uses the Exchange who indicated that he was now
growing his own coffee in order to meet the demands of the niche market, which he has been
unable to do when buying lots through the Exchange.
The ECX is certainly not an agricultural commodity exchange in the true sense of the word as it is
effectively a single channel marketing system for a number of commodities. At the recent Convening
of African Commodity Exchanges in Ethiopia, indications were given that the list of commodities to
be legislated for mandatory trade across the Exchange was likely to be increased, to incorporate most
of the commodities produced.
Perhaps the most significant fact to emerge from all of this is that despite the volumes and value of
trades conducted on ECX and the commissions charged by them, it is still not self sustainable.
Finally, the quotations below are from traders and other buyers who responded to questions put to
them during an independent study carried out for USAID/COMPETE to identify which market
segment(s) provide the greatest opportunity to grow the value and volume of Eastern Africa coffee
exports as well as define specific opportunities for the region to strengthen its position in the global
coffee market and was completed in May, 2010.
Whilst not referring to the ECX specifically, some of these quotes do lend weight to observations
made above. They also represent independent views on trade in coffee from Ethiopia.
Ethiopia
A high percentage of respondents (27.8%) purchase a significant volume of coffee from Ethiopia
(41-60%) and about half report paying USD$1.00 or more above market while another 37.3%
reported paying $0.51 to $1.00 more.
While quality marks were good, 32.7% disagreed with the statement It is easy to do business in
this region and a similarly high number (28.8%) disagreed with the statement I am able to get
sufficient information about the area or region where my coffee is grown.
When asked about the most positive aspects of buying coffee from Ethiopia, nearly all of the
responses were around unique and varied flavor profiles.
Character, all across the board. The different regions and prep give us an entire array of
flavors, aromas, and body.
Challenges noted included inconsistency in product, price, traceability, transit times, and
instability of business systems (including reliability of partners and recent changes).
(Response to greatest challenges with buying from Ethiopia): Timely shipping, traceability,
transparency, lack of direct relationships with growers.
The supply lines from the growing areas all the way to Djibouti port need to be totally
overhauled. Shipments are regularly late by 2-3 months or even more.
There was a strong sentiment of frustration about price not being commensurate with quality.
....pricing tend to push them out of a lot of blends and I feel often the pricing is going to
middlemen that provide little or no value in the chain. If I knew the farmer was getting most of
the money, I probably wouldn't mind paying as much
Price. Sometimes the price is not worth the taste. Also consisting in processing (washed or
natural).
...price and better sorting out of defects.
ZIMACE model, but this was not possible as there was no real market liberalization, combined
with continued Government interference in markets.
A re-assessment was carried out later and farmers and traders were asked what services they
wanted from KACE. Farmers wanted to know where they could sell their commodities, whilst
traders wanted to know where they were available to buy. Out of this, the current MIS evolved
into what it is today. Government still plays a significant role in agricultural markets
(particularly maize) despite the fact that they are theoretically liberalized. NCPB for their part
have resisted the idea of using their storage facilities for private sector (third party) storage.
However, with a radical change in the directors and a new Board having been put in place, this
direction is changing and they have the go ahead to form a new agricultural commodity
exchange, which it is envisaged will be a regional one for Eastern Africa, incorporating Kenya,
Tanzania and Uganda initially. By their own admission, KACE is not a commodity exchange,
but is an MIS provider.
NOTES:
1. MILS (Market Information and Linkage System) is the market information and
linkage system that has developed over the years, with funding from CTA,
Rockefeller Foundation, KMDP/USAID, AGRA, for providing market
information and market linkage services. It consists of various platforms: Market
Resource Centres, Mobile phone SMS, Interactive Voice Response service
(IVRS), RECOTIS (spreadsheet based system of disseminating information via
email), Radio (FM - Soko Hewani & KBC radio), and Internet website. KACE
collects, updates and disseminates market information (mainly wholesale buying
prices, offers and bids) using these platforms, targetting clients at various levels of
the commodity value chains. Work on these platforms has concentrated in western
Kenya (Western Province and North Rift - areas where Rockefeller/KMDP
projects were implemented).
2. Soko Hewani is an FM radio program (by the West Median Services based in
Bungoma, but covering an area with a radius of 200km, which covers parts of
Eastern Uganda, Western Province, Nyanza Province and North Rift Valley
provinces) where offers and bids are broadcasted to listeners and KACE provides
further back-end information and matching of offers and bids to clients who call.
3. E-services include email/internet services, money transfer services, processing of
Government forms electronically (e.g. tax forms, police forms, birth/death
certificates, passport forms, etc.).
4. KACE plan is to develop a web portal to provide a wider range of agricultural
information, including time series information on commodity prices, production,
consumption, exports and import data for selected commodities, and in the
analysis of these data to generate market intelligence (forecasts, trends, etc.). The
web portal would be designed in such a way that users can choose and access
modules of desired data/information on a payment basis, either subscription, or
payment through mobile phone money transfer systems such as M-Pesa of
Safaricom and Zap of Zain).
control ACE Ltd and have small operators and farming group interests be represented on the
board of Trustees of the ACE Trust.
ACE has been very successful of to date, with an Internet based trading platform, comprising of
the main platform, the BVO (Bid Volume Only) platform developed to meet the needs of the
P4P program of the WFP and now being used by other buyers and more recently the WRS
(Warehouse Receipt System), which are fully integrated. ACE continues to get smallholder
participation, both farmers and traders, in all these areas, which is a huge success for them given
the way in which trades were traditionally carried out in the past. An example of the potential
success of the WRS is expressed by a small trader below.
Mr Lawrence Chikhasu, owner of Bucow Investment, a small commodity trading company based
in Mchinji was the first take advantage of the system. I am a businessman and I need financing
to keep buying maize from farmers. The storage cost is higher than what I am used to, but my
maize is secure and the quality and quantity is guaranteed I dont have to think about post
harvest losses anymore. Mr Chikhasu deposited 14.5 MT and received 60% of the value, being
Mwk 261,000.00 at 20% interest per year. The warehouse receipt system is making it possible
for me to buy much larger volumes and keep the maize till the prices are good. I believe the price
of maize will be 35 to 40 kwacha/kg early next year when I want to sell my maize; so I will earn
a good premium after paying storage and interest cost.
A Warehouse Receipting System is being implemented by ACE and collaborating partners with
funds from USAID/COMPET, the European Union (EU) and Common fund for Commodities
(CFC). The funds cover development of the necessary software, building of 4 rural warehouses
(1400mt), developing partnerships with relevant stakeholders including insurance companies,
collateral managers, warehouse operators, banks, traders and farmer organisations. The first
phase of the project started in mid 2010, with the aim of developing partnerships and software,
which is acceptable by all stakeholders, to run the system. The Second Phase in 2011 marked the
trial year with the objective being to ensure that the system, including partner agreements, are
to benefit all stakeholders. It is important that partner agreements were at a cost that does not eat
away depositors margin after sale. In 2012 we aim to scale up all activities and advance receipts
to rural storage centres.
Looking ahead to 2012
o Financial prospects: The reserve bank of Malawi is setting up an export development
fund, partly to fund agricultural export initiatives through the use of the ACE warehouse
receipts. They are looking at allocating 200 million Kwacha (US$1,212,121 at the official
exchange rate) to finance such initiatives in Agricultural export marketing. Ace is looking
at way to collaborate with this fund in two ways, financing receipts which will be at a
more favorable interest rate on receipts marketed on the exchange for export locations,
this will not only attract large traders who usually get finance at a minimum of 18% but
will also encourage small holder farmers with limited critical margins. ACE is also
looking at this fund to help solve some constraints that are faced with medium to small
a trading stake, members cannot have any ownership stake, and the management can be neither
drawn from the owners nor from the members. ECX is designed as a public-private partnership
enterprise, in a unique institutional innovation for Ethiopia. At its inception, ECX is promoted by
the Government of Ethiopia and this still applies to date. The corporate governance of ECX
maintains a healthy balance of owner and member interests. Thus, the Management Board is
composed of Owner representatives and 5 Member representatives. As Owner, the Government
of Ethiopia underwrites all performance risk of the Exchange related to the Exchange operated or
appointed warehousing and grading of product, trading system, market information
dissemination, and clearing and settlement. Members, for their part, are liable for contract
performance on their own trades as well as of their Associates and Authorized Representatives.
There are obvious advantages to an exchange set up and operated with a large stake and interest
from the Government, including the volumes of trade conducted across the Exchange and the
price discovery that goes with that. However, there are also some disadvantages, including the
question of price discovery as, where you have a single marketing channel, which it is
compulsory to use one has to ask if this constitutes the best price opportunity or not, as the
market has not really been tested.
To leave market participants with no freedom of choice really just replaces previous single
channel marketing systems with a new one. The whole idea of a free market is that it is exactly
what it says it is by providing participants with the freedom to choose when, where and how they
want to buy or sell their commodities. In the case of Ethiopia, it has been legislated that anyone
dealing in coffee (with a few listed exceptions) is required to become a member of the Ethiopian
Commodity Exchange and to conduct all their business through the Exchange. Failure to do so
would mean that they can no longer trade in coffee. Latest indications are that this requirement
will be extended to include other agricultural commodities as well.
Arguments have been put forward that ensuring that all transactions are conducted through a
single organisation, in this case the ECX; more order is brought to the market. Whilst this might
be true, it can be argued that exchanges operating in countries elsewhere in the world, including
India, the USA, Europe and South Africa for example, achieve the same result without having to
make trade across them compulsory for all. These exchanges all operate on the basis of willing
buyer and willing seller, who have the right to choose whether or not to do business through an
exchange.
Aside from the lack of freedom of choice by market participants, the questions has to be asked as
to whether or not the ECX provides real market transparency or not? Again, there seem to be two
diverging opinions on this with the yes and no camps equally vocal in their views. Perhaps the
real test of this will be whether or not international buyers will use the services of the Exchange
in the longer run, although it is an open secret that buyers in the grain market are reluctant to do
so in the current circumstances.
There remains an argument that the lack of freedom of choice by market participants to use the
Exchange or not is a barrier to the free market. There is equally a valid argument regarding the
transparency of the operations, compared to other exchanges elsewhere, as well as the lack of
competition and the fact that effectively, for the moment at least, the ECX represents a form of
single channel marketing. The question of the Exchanges ability to supply the quality specified
in the contract has also been questioned, but perhaps this can be put down to the fact that
although the ECX is running and administering warehouses at the moment this is not, by their
own admission, their core business but has become necessary due to the lack of expertise in the
country.
That the ECX has made great strides in a short period of time cannot be denied. That this has
been achieved largely by home grown talent is commendable indeed and all involved are to be
congratulated on their achievements. At the end of the day though it will not matter what people
say in reports such as these or what individuals choose to think about the ECX, but it will depend
on the perception of the international trading communities as to how successful it will be. At the
moment the ECX is on the crest of a wave but it is still early days and the next five years are
likely to be crucial to the further development of the Ethiopian Commodity Exchange.
A recent development, which was highlighted at the Convening of African Exchanges in Addis
Ababa, when it was disclosed that moves are afoot to legislate that a wider range of commodities
be traded across the ECX, to capture those commodities produced in high volumes that are
currently excluded. However, this needs to be put into context as one of the major coffee traders,
who is on the board of the ECX, indicated that he is now growing his own coffee as farmers are
exempt from having to use the Exchange and he wants to get back the niche markets that were
lost when the Exchange commenced operations. Add to this the fact that despite all the volumes
traded, the ECX is still not self sustainable and it will indeed be an interesting few years ahead
for this Exchange.
Again, an exchange set up and operated through government legislation requiring that all trades,
with a few exceptions, have to be conducted through the exchange is not ideal. Transparency is
compromised, true market values are probably not realised by producers and quality issues are
likely to arise, as has happened in Ethiopia. Volumes are likely to be high, as there are no
alternatives, but neither is there likely to be much incentive to increase production if there is only
one market to sell through.