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Leonela Santana-Boado, Leonela Santana-Boado, Co-ordinator, Commodity Exchanges, Co-ordinator, Commodity Exchanges, Special Unit on CommoditySpecial Unit on Commodity, UNCTAD, UNCTAD

Leonela Santana-Boado@unctad-orgLeonela Santana-Boado@unctad-org

Introduction to Organized Commodity Markets

Virtual Institute Study Tour, University of Dar-es-SalaamGeneva, 17 February 2010

Outline of presentation

• The Commodity Economy and the need for Organized Commodity Markets

• Commodity exchanges: What are they?

• UNCTAD’s role in the area

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The commodities economy and poverty: There is a strong link

between them

"75 per cent of the 1.2 billion people living on less than $1 a day live and work in rural areas. Moreover, about half of the world's hungry people are from smallholder farming communities, another 20 per cent are rural landless and about 10 per cent live in communities whose livelihoods depend on herding, fishing or forest resources."

• Fragmented markets• Inadequate infrastructure• Information asymmetries• Limited access to affordable credit• Weak or absent sectoral support institutions• Globalising commodity supply chains with

rising barriers to small producer participation

Poor rural development

Declining commodity prices

• Real prices have been diminishing over the long term

• Price fluctuations are large and increasing

• Commodity price instability

Most recently: Domestic liberalization

• Unrealistic expectations

• Impact on farm gate prices is ambiguous and uncertain

• Absence of functioning markets poses unacceptable risks for producers

• Private sector has not filled the gap left by marketing boards and other support systems

Need for organized markets

The liberalisation of agricultural trade and the withdrawal of government support to agricultural producers outside the OECD, recent years have seen the rapid creation and growth of commodity exchanges in developing countries and countries with economies in transition.

Need for organized markets

The former Chicago Board of Trade (CBOT) was founded in 1848 by a group of Chicago merchants keen to establish a central marketplace for trade. Before that time, farmers all too often had found no buyers for the grain they had transported to Chicago. Given the high transport costs, they had been left with little choice but to dump the unsold produce in the lake.

Organized markets: Commodity Exchange, What is it?

• “A market in which multiple buyers and sellers trade commodity -linked contracts on the basis of rules and procedures laid down by the exchange.”

• This includes: Spot trade for immediate delivery of the commodity, forward contracts, warehouse receipts trading, commodity-based futures and options contracts, and trade facilitation services.

Commodity Exchanges

Over time, virtually all developed country exchanges moved towards futures trade (a mechanism for risk transfer), as their services in physical trade (spot and forward) became superfluous (most of the exchanges that were not able to make this change disappeared; the rare exceptions include the Dutch flower auction and a cheese exchange in the USA

THE WORLD’S MAJOR COMMODITY FUTURES EXCHANGES

2008 2007

Rank1 1 New York Mercantile Exchange

(NYMEX, US)

2 3 Dalian Commodity Exchange

(DCE, China)3 2 Chicago Board of Trade

(CBOT, US)

4 4 ICE Futures

(formerly IPE, UK)5 9 Zhengzhou Commodity Exchange

(ZCE, China)

6 5 London Metals Exchange

(LME, UK)

7 7 Shanghai Futures Exchange

(SHFE, China)8 10 Multi Commodity Exchange

(MCX, India)

9 11 New York Board of Trade

(NYBOT, US)

10 6 Tokyo Commodity Exchange

(TOCOM, Japan)

11 8 National Commodity & Derivatives Exchange

(NCDEX, India)

12 13 Chicago Mercantile Exchange

(CME, US)

13 12 Tokyo Grain Exchange

(TGE, Japan)

14 15 Euronext.LIFFE (EU)

15 16 Central Japan Commodity

Exchange (C-COM, Japan)

16 17 Kansas City Board of Trade

(KCBT, US)

17 18 Winnipeg Commodity Exchange

(WCE, Canada)

18 19 Bursa Malaysia Derivatives

(BMD, Malaysia)

19 14 National Multi-Commodity

Exchange (NMCE, India)

20 20 JSE/SAFEX

(South Africa)

21 22 Brazilian Mercantile & Futures

Exchange (BM&F, Brazil)

22 21 Minneapolis Grain Exchange

(MGEX, US)

Exchange Rank

THE WORLD’S MAJOR COMMODITY FUTURES EXCHANGES

BY SECTOR (2008)

0m

150m

300m

450m

600m

750m

Num

ber o

f co

ntr

acts

(fu

tures &

optio

ns)

Agriculture 200 313 93 223 64 - 4 6 18 13 8 - 4 - 3 3 0 3 1

Metals 86 - 126 - - 113 70 29 5 - - 5 - - - - 0 - -

Energy 339 - 62 - 153 - 21 6 1 - - - - - - - 3 - -

CME Group

DCE SHFE ZCEICE

FuturesLME MCX TOCOM NCDEX

NYSE Euronext

TGE TAIFEX KCBT NMCE BMDBM&F

BovespaC-COM

JSE/SAFEX

MGEX

LEADING AGRICULTURAL COMMODITY EXCHANGES 2008

DCE

CBOT

ZCE

NYBOT

NCDEX

CMETGE

LIFFETOCOM

MCX

KCBT

WCE

BMD

SAFEX

BM&F

MGEX

C-COM

0m

100m

200m

300m

400m

500m

600m

1

Num

ber

of c

ontr

acts

(fu

ture

s &

opt

ions

)

OECD exchanges

Non-OECD exchanges

PRINCIPAL CONTRACTS OF THE MAJOR COMMODITY EXCHANGES (2008)

40m37m

28m

20m 19m 17m13m

11m 11m

0

10

20

30

40

50

Num

ber o

f fut

ures

& o

ptio

ns c

ontr

acts

, m

illion

s

MAIN GRAINS TRADED IN THE MAJOR COMMODITY EXCHANGES IN THE WORLD

Dalian Commodity Exchange rice, corn, soyabeans(DCE, China)

Chicago Board of Trade corn, soyabeans(CBOT, US) wheat, riceZhengzhou Commodity Exchange wheat(ZCE, China)

Multi Commodity Exchange cereals (maize) (MCX, India)

New York Board of Trade wheat, barley(NYBOT, US)

National Commodity & Derivatives Exchange rice(NCDEX, India)

Tokyo Grain Exchange corn, soyabeans(TGE, Japan) red beansEuronext.LIFFE (EU) wheat, corns

Kansas City Board of Trade wheat(KCBT, US)

Winnipeg Commodity Exchange wheat, barley(WCE, Canada)

JSE/SAFEX maize, wheat, (South Africa) soyabeansBrazilian Mercantile & Futures corn, soyabeansExchange (BM&F, Brazil)

Minneapolis Grain Exchange wheat, corn, (MGEX, US) soyabeans

Exchange Main grains

Traded

Commodity Exchanges

In the developing world, a commodity exchange may act in a broader range of ways to stimulate trade in the commodity sector. This may be through the use of instruments other than futures, such as the cash or 'spot' trade for immediate delivery, forward contracts on the basis of warehouse receipts or the trade of farmers' repurchase agreements, or 'repos'. Alternatively, it may be through focusing on facilitative activities rather than on the trade itself, as in Turkey where exchanges have served as a centre for registering transactions for tax purposes.

EXCHANGES IN AFRICA:

The SAFEX Agricultural Products Division of the JSE Exchange, South Africa is the continent’s only commodity futures exchange, and the only commodity exchange in Africa that has truly withstood the test of time.

OTHER EXCHANGES IN AFRICA

• MACE (Malawi); The Malawi Agricultural Commodity Exchange• KACE (Kenya); The Kenya Agricultural Commodity Exchange• UCE (Uganda); The Ugandan Commodities Exchange• ECEX (Ethiopia); Ethiopia Commodity Exchange• ZAMACE (Zambia); The Zambia Agricultural Commodity Exchange• ASCE (Nigeria); Abuja Securities and Commodity Exchange• Ghanaian Commodities Exchange- in project• ACE (regional, based in Malawi);• Bourse Africa (Regional)

Bourse Africa

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AACP: An introduction

• The All ACP Agricultural Commodities Programme (AACP) is a joint project involving:– the European Union (EU) – the African, Caribbean and Pacific secretariat (ACP)– five international organisations (IOs): UNCTAD, CFC, ITC, FAO and the

World Bank

• A budget of €45 million has been set aside for actions by the IOs to address ACP stakeholders’ needs

• The Programme’s actions will be demand-driven, arising from participatory consultative processes to ensure ownership by ACP stakeholders (national and regional)

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Potential benefits for developing countries

Market creation

Stimulating regional inte- gration & South-South trade

Price discovery

Price risk management

Infrastructure enhancement

Market access

Facilitate provision of finance

Price transparency

Reduced counterparty risk

Quality assurance/upgrade

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Caveat: Benefits do not automatically flow from the establishment of a

commodity exchange• A domestic commodity exchange is not necessarily an appropriate policy

instrument for all markets and all commodities.

• An exchange is only one part of the policy framework – it is not a panacea and it does not stand alone from other commodity policy interventions

• An exchange which is badly-structured or poorly-managed is unlikely to deliver enhancements to underlying commodity sectors.

• The extent to which prospective enhancements are delivered in large part depend on the services offered and the strategic priorities pursued by the exchange.

• A well-functioning commodity exchange is predicated upon a robust legal-regulatory framework

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UNCTAD and Commodity Exchanges

• UNCTAD is the major international organization supporting commodity exchange development: 15 years of hands-on support

• Aims to: promote understanding; facilitate sharing of experiences, perspectives and ideas; enhance developing country capacity and expertise; ensure viability and sustainability of exchange initiatives

• Expertise is concentrated in two areas: – Direct technical assistance and advice, with involvement in the Dominican

Republic, Ghana, Kazakhstan, India, Indonesia, Malaysia, Nigeria, Russia, Sri Lanka, Turkey and Ukraine, as well as a regional exchange for Africa

– Awareness-raising through publications, presentations and the organization of conferences

Commodity exchanges development: What can UNCTAD do?

• To assess the relevance of existing commodity exchanges initiatives and identify if it could be an appropriate solution and how to make them more efficient and useful for farmers

• To scan and analyze the conditions depending on the type of Commodity Exchange (physical commodity exchange, commodity futures exchanges, etc.);

• Creating a new commodity exchange is no easy matter – how is it to be organized, what contracts are to be traded (UNCTAD has done several feasibility studies), what are the possibilities with respect to trading platforms, how does one target potential users, what types of regulation are required.

Exchange creation and Exchange creation and growthgrowth

What can UNCTAD do?

• UNCTAD is ideally placed to overcome the trust gap that often still exists between the public and private sectors in developing countries and which hinders investments in trade-related institutions.

• Identify the components of the legal-regulatory frameworks required for the functioning of different types of services provided by a commodity exchange (rules, taxation)

A public-private A public-private orientationorientation

What can UNCTAD do?

• Organize Capacity building and training programmes that addresses the needs of the various stakeholders;

• Visit to sucessfull Exchanges both inside and outside the region;

Bridging the Bridging the information gapinformation gap

What can UNCTAD do?

Warehouses

National exchanges tied into a pan-African network

Exchange of Exchange of Innovative ideas: Innovative ideas:

Regional DimensionRegional Dimension

Creation of regional linkages

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UNCTAD Analysis, 2009 – A Study of Development Impacts of Commodity Exchanges

in Developing Countries• Aim: To identify, analyse and assess the impacts made by commodity futures exchanges

in developing countries on economic growth, development and poverty reduction, with particular focus on agriculture

• Study undertaken in collaboration with leading exchanges in Brazil, China, India, Malaysia and South Africa

• Verified 66 positive impacts that commodity exchanges have made in the following areas: price discovery, price risk management, venue for investment, facilitation of

physical trade, facilitation of finance and general market development

• Also identified versatility of exchanges across different contexts and in response to different challenges – existing and emerging – including in a context of smallholder

farming

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Aim and Objectives

• Aim: To identify, analyse and assess the impacts made by commodity exchanges in developing countries on development, poverty reduction and economic growth, with particular focus on the agricultural sector and farmers

• Objectives:– Awareness-raising among governments and sector stakeholders– Knowledge development about the impacts of agricultural commodity

exchanges– Best practice identification and promotion– Demonstrate worldwide applicability where it exists– Exchange of information, experience and perspectives – Network-building among South-based exchanges

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Scope

• Commodity futures exchanges have been selected as the focus of the study because they tend to be the most sophisticated adaptation of a commodity exchange – The array of impacts generated is potentially the broadest– A commodity exchange that offers other services but not futures

trading is likely to generate impacts that feature only a sub-set of those generated by commodity futures exchanges

• However, this selection does not imply:_– that a commodity futures exchange is always the appropriate form of

exchange to be established in every market or for every commodity– that every commodity futures market always in reality generates a

wider array of impacts than other forms of commodity exchange– that a commodity futures exchange will always generate the same

range of impacts as those identified in this study

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Approach

• Country case studies - a comparative review of agricultural futures exchanges in five key developing economies: – Under what conditions they have emerged

– The factors that have driven their ongoing development

• Impact assessment research methodology:– Designing a framework for analysing 81 potential development

impacts arising from agricultural futures contracts and supporting services offered by commodity exchanges participating in the Study Group

– Conducting an empirical investigation into these 81 impact hypotheses in each of the featured countries

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Participants

•Africa •South Africa •JSE/SAFEX •White Maize

•Wheat

CountryRegion ExchangeFeatured contracts

•Latin America •Brazil • Bolsa de Mercadorias & Futuros (BM&F)

•Coffee

•Live Cattle

•East Asia •China •Dalian Commodity Exchange (DCE)

•Soybean

•Maize

•South Asia • India •Multi Commodity Exchange (MCX)

•Cardamom

•Mentha Oil

•South East Asia •Malaysia •Bursa Malaysia •Crude Palm Oil

A study group comprising the leading agricultural futures exchange by volume in each developing region, with a focus on two commodities traded at each:

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Impact framework (1)

Price discoveryPrice risk

managementInvestment

venue

More efficient price formation

Wider supply of more accurate

information

Effective transfer of price risk

Improved investment

environment

Core functions

14 hypotheses 8 hypotheses 14 hypotheses

Exchange functions

Benefits arising

Impacts on beneficiaries1

(81 in total)

1 Impact hypotheses are further split into potential impacts specifically or mainly for farmers (37) and potential impacts for the wider commodity sector or the overall economy (44); and potentially positive impacts (76) and potentially negative impacts (5). The full list of impacts can be found in the working paper version of the study, available at: www.unctad.org/commodities

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Impact framework (2)

Exchange functions Facilitation of physical trade

Market development

Facilitation of financing

Improved spot reference price

generation

Reinforce cash market transactions

Enhances storage & logistics infra-

structure

Upgrades quality standards

Education & capacity-building

International trade facilitation

Technology upgrade & promotion

Industry growth

Enables bank lending & other modes of

financing

Wider functions

18 hypotheses 9 hypotheses 18 hypotheses

Benefits arising

Impacts on beneficiaries1

(81 in total)

1 Impact hypotheses are further split into potential impacts specifically or mainly for farmers (37) and potential impacts for the wider commodity sector or the overall economy (44); and potentially positive impacts (76) and potentially negative impacts (5). The full list of impacts can be found in the working paper version of the study, available at: www.unctad.org/commodities

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Impact results

• Of 81 impact hypotheses, evidence was found to support the occurrence of 69 of these in at least one of the featured markets2

– 31 related to farmers, 38 to the wider commodity sector or overall economy

– 66 positive impacts, 3 negative impacts

• The study suggests that farmers do not need to directly use the exchange to realise benefits from it:

– Indirect usage via aggregators (e.g. cooperatives, purchasers, financiers)

– Benefits arising from transparent dissemination of market information

•The study also suggests that many impacts – particularly those related to facilitation of the physical market - can be realised without the exchange needing to offer trade in futures

2 The performance in each exchange for 81 impact hypotheses, along with documentation of evidence, can be found in the working paper version of the study, available at: www.unctad.org/commodities

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Bolsa de Mercadorias & Futuros, Brazil (BM&F)

Context • Continuous commodity trading in Brazil since

early 20th century

• The exchange’s room for action squeezed by varying levels of government intervention

• Agro-liberalisation and deregulation in the 1980s, and increased export orientation

Development impacts• Distributed across core and wider functions

• Hedging and price discovery are prominent

• The BM&F subsidiary, “Brazilian Commodity Exchange” has integrated national cash markets and enables financing and export promotion possibilities for agro-participants

Key achievements• Providing services that have supported the

commercialization of the agro-economy

e.g. enabling flow of capital into the sector; enhancing efficiency and transparency of government support; integrating the domestic physical market; facilitating export markets

Relevance to smallholders• BM&F mechanisms used by Government to

support smallholders schemes e.g. auctions to support government procurement; channeling finance to smallholders and providing a secondary market

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Dalian Commodity Exchange, China (DCE)

Context • Established during economic reform period as

Government looked to build market institutions

• The exchange as a mechanism to support moves towards framework for market pricing and market opening

Development impacts• Focused primarily on core price discovery and

price risk management functions

• Important emphasis also on capacity-building for farmers to use market information

• Financing functionalities are nascent but have strong growth potential

Key achievement• Creating high levels of liquidity for key agro-

commodities

e.g. generated significant trading volumes in strategic commodities; enhanced market functioning; adapted to emerging dynamics in important markets - liberalisation, GMO

Relevance to smallholdersMajor training and capacity-building execerise

by DCE to help smallholders improve cropping and marketing decisions with market information

DCE encourages downstream partners to pass on hedging benefits to smallholders

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Multi Commodity Exchange, India (MCX)

Context • Heavy government intervention, including

prohibition on futures trading until 1980s

• Three national multi-commodity exchanges a key element of Government plan to upgrade fragmented and infrastructure-deficient commodity markets

Development impacts• Distributed across core and wider functions

• Price discovery and dissemination a key impact

• Impacts arising from facilitation of physical market and market development have been high

Key achievement• Catalyzing development of the wider

commodity ecosystem

i.e. as well as price risk management, has also improved the flow of information, facilitated physical infrastructure development, established reliable quality standards

Relevance to smallholdersHigh expectation for direct farmer participationCurrent usage is low, but high impacts from

information & physical market development Indirect participation of small farmers via co-

operatives Regulatory obstacles

India can lead the way in integrating farmers into national and international market places using modern information

and communications technologies

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Bursa Malaysia

Context • Established in 1980 on the back of a well-

developed and strongly-regulated physical market for crude palm oil

• The consummation of the Government’s diversification strategy, originating in the early 1960s

Development impacts• Mainly arising from core functions

• Price discovery and price risk management for world palm oil industry

Key achievement• Bringing pricing power to Malaysia for its key

export commodity

i.e. unique in establishing a benchmark exchange in the developing world, ensuring pricing power for its key export commodity on the world market.

Relevance to smallholders• No observed smallholder focus - development

impact has been elsewhere

• Many smallholders operates within government support schemes

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JSE/SAFEX, South Africa

Context • Heavy government intervention in the agro-

markets until political transition brought on by the demise of the apartheid regime

• Root-to-branch liberalisation in mid-1990s entrenched market pricing and an open, unprotected and volatile grain sector

Development impacts• Distributed across core and wider functions

• Price discovery and risk management key in supporting sector performance despite high levels of price and production volatility

• High impact in enabling financing and facilitating physical market development

Key achievement• Filling the void left by sudden government

deregulation of the markets

i.e. has become a core institution in the deregulated South African grain markets, for the conduct of hedging, financing and cash transactions

Relevance to smallholders JSE/SAFEX supports smallholder capacity-

building programmes in partnership with other agencies

Indirect usage of the exchange's market information has been encouraged.

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Conclusions

Exchanges are versatile instruments, capable of upgrading commodity sector performance in a range of situations and addressing emerging challenges as they arise

In general, exchange services are relevant for smallholders however, price risk management is not always an important - or even

relevant service - for smallholders compared with price information and physical market services

The exchange is not a panacea, and has depended on an appropriate regulatory environment and other complimentary policies and mechanisms