Commodity Exchange Development. Adam GROSS, NEPAD Business Foundation.

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1 Brussels Development Briefing n.35 Revolutionising finance for agri-value chains 5 March Commodity Exchange Development. Adam GROSS, NEPAD Business Foundation.

2 COMMODITY EXCHANGE DEVELOPMENT Brussels Policy Briefing no 35: Revolutionising Finance for Agri-Value Chains Brussels (Belgium), 5 March 2014 Adam Gross Investments & Capital Markets Advisor NEPAD Business Foundation Director Darhei Noam Emerging Markets Advisory adam.gross@thenbf.co.za adam@noamlimited.com

3 Context and Aims of this Presentation This panel presents concrete examples which demonstrate the potential of value chain finance for shaping African agriculture. This presentation aims to share agricultural commodity exchange experiences in Africa, its implications for value chain finance, and the lessons learned. This presentation seeks to: 1. Describe high-level what a commodity exchange is and how it works 2. Identify benefits and risks, including for value chain finance 3. Evaluate African experience an early view on successes and lessons

4 Types of Commodity Exchange * Futures and options are types of derivative Futures & Options Exchange* Price risk management instruments Price discovery for the future Financial marketplace/few deliveries Forwards Exchange Similar to spot but future delivery Cash versus Delivery (or transfer of WR) May require collateral to deter default Spot Exchange Trade is for delivery today or the very near future Cash versus Delivery (or transfer of WR) Trade is sight unseen, on basis of standardised quality Warehouse Receipt System WR = specified quality and quantity of commodity at specified location A document of title (i) collateral for bank finance to the commodity chain (ii) a means to effect sale of the commodity

5 A Farmers Perspective of a Comex FROM FARMGATE TO THE COMMODITY EXCHANGE WAREHOUSE Harvest Transport to Warehouse Weighing / Grading Issuance of Warehouse Receipt Storage OPTION 1: SELL IMMEDIATELY THROUGH THE EXCHANGE Sell through Exchange Pay Storage Fee Receive Cash OPTION 2: TAKE FINANCE; SELL THROUGH EXCHANGE LATER IN THE SEASON WHEN PRICES ARE HIGHER Finance the Warehouse Receipt Wait for Prices to Improve Sell through Exchange Pay Storage Fee and Repay Loan Receive Cash

6 Comex Pillars and Building Blocks REGIONAL EXCHANGE DOMESTIC EXCHANGE PILLARS TO SUPPORT A DOMESTIC MARKET EXTRA PILLAR TO SUPPORT REGIONAL MARKET Agri-Storage Infrastructure Quality Standards Aggregation of Smallholder Production Trading Platform Warehouse Receipt System Legal-Regulatory Framework Cross-Border Logistics & Customs Cross-Border Currency, Capital & Tax Regime Cross-Border Commodity Regime Cross-Border Legal- Regulatory Regime PHYSICAL MARKET PILLAR INSTITUTIONAL PILLAR REGIONAL PILLAR Darhei Noam (Pty) Ltd 2013

7 Benefits Studies e.g. UNCTAD 2009 show more than 70 benefits Categories of benefit: Price Discovery & Transparency Financing of the Commodity Physical Trade & Competitive Markets Price Risk Management However, benefits are not assured It is not easy to set up an exchange... it is even harder to make it work Harm can be done if key risks are not addressed

8 Potential Benefits: A More Detailed Look - Finance Category Financing the Value Chain Potential Benefits from a Comex/WRS Farmers have liquid collateral Banks can value the collateral against a market price Banks can easily liquidate collateral through the exchange System ensures collateral is pledged only once The exchange manages performance through a defined settlement cycle, including guarantees against default Interest rates on loans can be lower as risks are lower (especially when a position is hedged through price risk management to lock in a forward price) Liquidity to list and finance innovative products e.g. repos Support key aspects of the value chain finance transaction: pricing, collateral, pledging, valuing, liquidation, performance, risk management and liquidity

9 Potential Benefits: A More Detailed Look - Others Category Price Discovery & Transparency Physical Trade & Competitive Markets Price Risk Management Potential Benefits from a Comex/WRS Farmers can readily come to know the market price Prices are competitive reflecting demand and supply Farmers have a pricing incentive to increase quality Prices guide when to store/sell, and what to plant next season (futures) Farmers access professional storage reduce post-harvest losses Farmers can sell later in the season when prices are better Farmers can find out where to deliver Farmers can find out the prevailing quality standards Farmers can receive cash for a market price at time of delivery Certainty of supply stimulates processing and downstream industries Trade across borders by buyers & sellers stimulates regional integration Farmers can lock in their price at time of harvest (futures) or secure a minimum price (options) Processors can lock in their purchase and sales price to fix their margins A fixed price gives farmers and chain players a sounder basis to invest in upgrading their activities

10 Key Risks to Commodity Exchanges Risk Implication Mitigation Policy Risk Legal- Regulatory Risk Market Risk Product Risk Credit Risk Exclusion Risk Government policy undermines the exchange The exchange cannot enforce fair trading conditions The exchange does not persuade sellers and buyers to participate Products traded on the exchange are not accepted by the market Defaults take place which prejudices buyers and sellers on the other side of the trade The exchange reinforces existing patterns of exclusion Positioning an exchange as a component of government policy Building an appropriate legalregulatory environment Adding value to buyers and traders as well as sellers (farmers) Appropriate selection & specification of commodities to be traded Good risk management ( clearing & Settlement ) which guarantee trade in the event of default Focus on ensuring access, aggregation and capacity-building

11 African Experience to Date JSE/SAFEX (SOUTH AFRICA) Created in 1994 Commercial funding Developed infrastructure Commercial farming Large market Sophisticated banking sector took the lead in creating the market Electronic WRS Futures and options as key products ACE (MALAWI) Created in 2004 Budget Donor funding Underdeveloped infrastructure Smallholder farming Small market Banking sector only became involved later on once WRS took off Paper-based WRS WFP & NFRA Tenders / WRS financing / Spot ECX (ETHIOPIA) Created in 2008 High Donor funding Quite developed infrastructure Smallholder farming Medium market Banking sector followed via government instruction Electronic WRS Spot Market

12 African Successes an Early View CAN COMMODITY EXCHANGES WORK IN AFRICA? South Africa, Malawi and Ethiopia show a comex can work in any African context.. South Africa is a middle income country with commercial farming Ethiopia is a large least developed country with smallholder farming Malawi is a small least developed country with smallholder farming HAVE COMMODITY EXCHANGES BEEN BENEFICIAL FOR AFRICA? In South Africa, Malawi and Ethiopia, prices are known by farmers.. Farmers have direct access to storage, finance and markets.. Farmers store and sell later in the season when prices are higher, supported by Warehouse Receipt finance.. quality standardised commodity is bought by processors and offtakers from farmers through the exchange for a market price.

13 Lessons in Africa an Early View Previous initiatives in Kenya, Nigeria, Ghana and Zambia, among others, have not as yet met with success, despite investment and political will.. Some Key Challenges: Misalignment with government policy forms of interventionism and restriction, legacy of anti-commercial mindset, a misunderstanding of an exchange s role Value needs to be created for all stakeholders: Understandable focus on creating value for producers (the political priority) without enough thought or focus on also creating value for traders/processors/offtakers Standardising the commodity quality without losing its distinctiveness Insufficient focus on (i) guarantees and (ii) access to finance in particular through a robust model for default management ( clearing and settlement ), and a strong WRS National markets are small a regional market creates economies of scale that attract buyers and reduce transaction costs

14 THANK YOU!