Introduction to Organized Commodity Markets

Leonela Santana-Boado, Co-ordinator, Commodity Exchanges, Special Unit on Commodity, UNCTAD Leonela Santana-Boado@unctad-org
Virtual Institute Study Tour, University of Dar-es-Salaam Geneva, 17 February 2010
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Outline of presentation
The Commodity Economy and the need for Organized Commodity Markets Commodity exchanges: What are they? UNCTADs role in the area

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."

Poor rural development

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

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 WORLDS MAJOR COMMODITY FUTURES EXCHANGES

2008 2007 Exchange 1 3 2 4 9 5 7 10 11 6 8 13 12 15 16 17 18 19 14 20 22 21 New York Mercantile Exchange (NYMEX, US) Dalian Commodity Exchange (DCE, China) Chicago Board of Trade (CBOT, US) ICE Futures (formerly IPE, UK) Zhengzhou Commodity Exchange (ZCE, China) London Metals Exchange (LME, UK) Shanghai Futures Exchange (SHFE, China) Multi Commodity Exchange (MCX, India) 9 10 11 12 13 14 15 16 17 18 19 20 21 22 New York Board of Trade (NYBOT, US) Tokyo Commodity Exchange (TOCOM, Japan) National Commodity & Derivatives Exchange (NCDEX, India) Chicago Mercantile Exchange (CME, US) Tokyo Grain Exchange (TGE, Japan) Euronext.LIFFE (EU) Central Japan Commodity Exchange (C-COM, Japan) Kansas City Board of Trade (KCBT, US) Winnipeg Commodity Exchange (WCE, Canada) Bursa Malaysia Derivatives (BMD, Malaysia) National Multi-Commodity Exchange (NMCE, India) JSE/SAFEX (South Africa) Brazilian Mercantile & Futures Exchange (BM&F, Brazil) Minneapolis Grain Exchange (MGEX, US)

Rank
1 2 3 4 5 6 7 8

Rank

THE WORLDS MAJOR COMMODITY FUTURES EXCHANGES BY SECTOR (2008)

750m

Number of contracts (futures & options)

600m

450m

300m

150m

0m CME Group Agriculture Metals Energy 200 86 339 DCE 313 SHFE 93 126 62 ZCE 223 ICE Futures 64 153 LME 113 MCX 4 70 21 TOCOM 6 29 6 NCDEX 18 5 1 NYSE Euronext 13 TGE 8 TAIFEX 5 KCBT 4 NMCE BMD 3 BM&F Bovespa 3 C-COM 0 0 3 JSE/SAF EX 3 MGEX 1 -

LEADING AGRICULTURAL COMMODITY EXCHANGES 2008

600m TOCOM LIFFE TGE

MCX

WCE KCBT

SAFEX BMD

MGEX

BM&F C-COM

CME 500m
Number of contracts (futures & options)

NCDEX NYBOT

400m ZCE 300m CBOT 200m

100m

DCE

OECD exchanges Non-OECD exchanges

0m 1

Number of futures & options contracts, millions

DC E No .1

10

20

30

40

50

DC E

so yb ea n

40m

so yb ea n m ea l

37m

CB OT CB OT NC DE X gu ar se ed st ro n g gl ut en wh ea t ga r so yb ea ns co rn

28m 20m

ZC E

19m

TG E No nGM O su

NY BO T 11

17m 13m

ZC E

so yb ea ns co tt o n

PRINCIPAL CONTRACTS OF THE MAJOR COMMODITY EXCHANGES (2008)

11m

no .1

11m

MAIN GRAINS TRADED IN THE MAJOR COMMODITY EXCHANGES IN THE WORLD

Exchange Dalian Commodity Exchange (DCE, China) Chicago Board of Trade (CBOT, US) Zhengzhou Commodity Exchange (ZCE, China) Multi Commodity Exchange (MCX, India) New York Board of Trade (NYBOT, US) National Commodity & Derivatives Exchange (NCDEX, India) Tokyo Grain Exchange (TGE, Japan) Euronext.LIFFE (EU) Kansas City Board of Trade (KCBT, US) Winnipeg Commodity Exchange (WCE, Canada) JSE/SAFEX (South Africa) Brazilian Mercantile & Futures Exchange (BM&F, Brazil) Minneapolis Grain Exchange (MGEX, US) Main grains Traded

rice, corn, soyabeans corn, soyabeans wheat, rice wheat cereals (maize) wheat, barley rice corn, soyabeans red beans wheat, corns wheat wheat, barley maize, wheat, soyabeans corn, soyabeans wheat, corn, soyabeans

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 continents 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

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 Programmes 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 integration & South-South trade Price discovery

Market access
Facilitate provision of finance Price transparency

Price risk management

Infrastructure enhancement

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

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Commodity exchanges development: What can UNCTAD do?

Exchange creation and growth

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.

What can UNCTAD do?

A public-private orientation

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)

What can UNCTAD do?

Bridging the information gap

Organize Capacity building and training programmes that addresses the needs of the various stakeholders; Visit to sucessfull Exchanges both inside and outside the region;

What can UNCTAD do?

Exchange of Innovative ideas: Regional Dimension

Creation of regional linkages

Warehouses National exchanges tied into a pan-African network

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
A study group comprising the leading agricultural futures exchange by volume in each developing region, with a focus on two commodities traded at each: Region Africa Country South Africa Exchange JSE/SAFEX Featured contracts White Maize Wheat Coffee Live Cattle Soybean Maize Cardamom Mentha Oil Crude Palm Oil
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Latin America

Brazil

Bolsa de Mercadorias & Futuros (BM&F) Dalian Commodity Exchange (DCE) Multi Commodity Exchange (MCX) Bursa Malaysia

East Asia

China

South Asia

India

South East Asia

Malaysia

Impact framework (1)

Core functions
Exchange functions

Price discovery

Price risk management

Investment venue

Benefits arising

More efficient price formation Wider supply of more accurate information

Effective transfer of price risk

Improved investment environment

Impacts on beneficiaries1 (81 in total)

14 hypotheses

8 hypotheses

14 hypotheses

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)

Wider functions
Exchange functions Facilitation of physical trade Facilitation of financing Market development

Benefits arising

Improved spot reference price generation Reinforce cash market transactions Enhances storage & logistics infrastructure Upgrades quality standards

Enables bank lending & other modes of financing

Education & capacitybuilding International trade facilitation Technology upgrade & promotion

Industry growth

Impacts on beneficiaries1 (81 in total)

18 hypotheses

9 hypotheses

18 hypotheses

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 34

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

Context
Continuous commodity trading in Brazil since early 20th century The exchanges room for action squeezed by varying levels of government intervention Agro-liberalisation and deregulation in the 1980s, and increased export orientation

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

Development impacts

Relevance to smallholders

Distributed across core and wider functions BM&F mechanisms used by Government to support smallholders schemes e.g. auctions to Hedging and price discovery are prominent support government procurement; channeling The BM&F subsidiary, Brazilian Commodity Exchange has integrated national cash markets finance to smallholders and providing a secondary market and enables financing and export promotion possibilities for agro-participants

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Dalian Commodity Exchange, China (DCE)

Context Key achievement
Established during economic reform period as Creating high levels of liquidity for key agroGovernment looked to build market institutions commodities The exchange as a mechanism to support e.g. generated significant trading volumes in moves towards framework for market pricing strategic commodities; enhanced market and market opening functioning; adapted to emerging dynamics in important markets - liberalisation, GMO

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

Relevance to smallholders
Major 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

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

Development impacts

Relevance to smallholders

High expectation for direct farmer participation Distributed across core and wider functions Price discovery and dissemination a key impact Current usage is low, but high impacts from information & physical market development Impacts arising from facilitation of physical Indirect participation of small farmers via comarket and market development have been operatives high Regulatory obstacles

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

Bursa Malaysia
Context Key achievement
Established in 1980 on the back of a well Bringing pricing power to Malaysia for its key developed and strongly-regulated physical export commodity market for crude palm oil i.e. unique in establishing a benchmark The consummation of the Governments exchange in the developing world, ensuring diversification strategy, originating in the early pricing power for its key export commodity on 1960s the world market.

Development impacts
Mainly arising from core functions Price discovery and price risk management for world palm oil industry

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 agromarkets 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

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

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

Relevance to smallholders
JSE/SAFEX supports smallholder capacitybuilding 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

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