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Tuesday, October 28, 2014

REPORT: Current status of the major Agricultural Commodity Exchanges in Sub-Saharan Africa

Highlight in this excerpt:

  • Three exchanges (SAFEX, ECX, and MACE) remain operational but only SAFEX is clearly sustainable and thriving based on the voluntary participation of all relevant market participants, and without significant external donor funding to sustain its operations.  
  • While it is sometimes argued that the ECX has promoted the welfare of coffee farmers as the value of exports has increased from $529 million in 2007 when the exchange was established to $797 million in 2012, others indicate that this rise can be almost totally explained by the increase in international coffee prices over this period. Moreover, recent analysis of ECX data indicate that the farmers’ share of the international coffee prices has not risen compared to pre-ECX farmer shares.  [footnote 14: For example, data from the International Coffee Organization indicates that farmers took home 51.6% of the export price of their product for the year ended September 2012, down from 57.1% in the year ended September 2007, before the exchange was established.] ECX has apparently been unwilling to publicly share its data on prices received by farmers until quite recently, and has not accepted invitations by IFPRI and Oxford to carry out impact assessments on the ECX’s activities. Clearly more detailed assessments are necessary to understand how the ECX has affected the welfare of Ethiopian coffee producers.
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Agricultural Commodity Exchanges and the Development of Grain Markets and Trade in Africa: A Review of Recent Experience

By T.S. Jayne, Chris Sturgess, Ron Kopicki, and Nicholas Sitko
Indaba Agricultural Policy Research Institute (IAPRI)


October 2014

Executive Summary

Vibrant agricultural commodity exchanges will greatly enhance the performance of Africa’s agricultural sectors and contribute to overall economic development. Yet specific conditions in grain markets are required for agricultural commodity exchanges to develop.1 The absence or short-lived nature of many of these conditions explains why commodity exchanges for staple grains have remained stunted in Sub-Saharan Africa despite strong interest in their development by the international donor community and by most elements of the private sector. This study identifies these preconditions and assesses the scope for development organizations to support the sustainable development of commodity exchanges in eastern and southern Africa.

Six main factors impede trading on agricultural commodity exchanges in the region. They are: (1) limited success in attracting financial institutions’ commitment to commodity exchanges, both as agents who are able to complete the transfer of payments from buyer to seller and as lenders to exchange participants; (2) the failure of exchanges to offer contracts that respond to unmet trader needs, especially those seeking mechanisms for hedging quality, price and delivery risk; (3) the inability of commodity exchanges to reduce the transaction costs of exchange, which is one of the major theoretical benefits of a commodity exchange.

The anonymous nature of trading on a commodity exchange can exacerbate trading risks rather than reduce them when contract safeguards are missing and contract compliance is only weakly enforced; (4) the potential for conflict of interest among brokers who also act as off-market traders; (5) the potential for market manipulation, which occurs when markets become thinly traded, for example when marketing boards purchase a significant portion of the national marketed output or when risks associated with trading on an exchange are asymmetric between buyers and sellers; and (6) actors trading in thin markets are forced to absorb high fixed costs when limited trading volumes do not allow costs to be amortized over a large volume base of transactions. Exacerbating all these factors is the unpredictability of government intervention in commodity markets.

Factors that signal a hospitable environment for the introduction of grain commodity exchanges include (1) a readiness of financial and banking firms to fulfil commodity exchange transactions and to lend to actors in the grain sector based on a perception that it is profitable for them to do so; (2) a strong demand and willingness to pay among actors in the grain industry for risk-shifting instruments; (3) a management entity that is perceived to be trustworthy, even-handed, and yet decisive in its approach to resolving contract disputes between market participants, based on clearly defined rules of behavior for participating on the exchange; (4) transparent rules governing the behavior of brokers; (5) a commitment from governments to adopt transparent and predictable rules for direct state operations in grain markets, including trade policies; and (6) vibrant spot markets with large trade volumes are already in place.

It is not necessary for all of these factors to be in place before donor organizations can meaningfully support the development of agricultural commodity exchanges. The important point is to conceive of support for commodity exchanges holistically, recognizing that all commodity exchanges operate within a system, and that support for overcoming weak aspects of the grain marketing system will be needed as part of a comprehensive program to support the development of agricultural commodity exchanges. Development partners can play a catalytic role in supporting the development of agricultural commodity exchanges as long as there is sufficient commitment, first from actors in the financial and commodity sectors, and secondly from governments to ensure stable and predictable commodity marketing and trade policies. Development partners could assess, on the case by case basis, the degree to which this commitment exists. In the more favorable countries, donors could provide interim support for basic nuts and bolts strengthening of the grain marketing system (e.g., warehouse certification services, collateral management and settlement services, contract dispute resolution processes, investments in transportation infrastructure), while also nurturing the status of the six conditions specified above.

Fortunately, there are signs of increasing commitment to the development of commodity exchanges by some governments in the region. Detailed consultations are needed to ensure that governments understand how commitment to the development of commodity exchanges would circumscribe their behaviour and policy choices. In particular, prospects for the sustained development of commodity exchanges are highest where governments are prepared to accept a more limited and predictable approach to intervening in grain markets and to trade policy. To date, most governments have considered such commitments to impose unacceptable constraints on their mandate to ensure national food security.

A major conclusion from this study is that commodity exchanges should not be viewed as panaceas for rectifying the many challenges facing African agricultural markets. The development of a commodity exchange is not an end in itself, but is rather an important component in the process of developing efficient marketing and trading systems that promote social welfare. While commodity exchanges can improve the efficiency of markets in the region, they cannot be expected to impose order on dysfunctional markets. Only once the major grain markets of the region are able to achieve minimum threshold levels of policy stability will investment in commodity exchanges begin to contribute meaningfully to market performance and to advancing national food and agricultural policy objectives.

Ethiopia (page 17)

In their efforts to promote national markets for agricultural products, the pioneers who organized ECX had to overcome several daunting challenges. In the months following ECX’s launch, maize, wheat, and beans were the primary traded commodities.13 However, at this time a food price crisis swept across Ethiopia. Domestic grain prices both on and off the exchange spiked amid rumors grew that exchange trading would cause further hikes. Trading on the ECX was nearly brought to a halt. This crisis in food grain trading accelerated ECX’s push to introduce new commodities with more assured market liquidity and price stability.

The exchange turned to coffee, an export commodity, which the exchange’s management had planned to introduce in a later phase in any case, as well as to sesame seed, another important export commodity in Ethiopia. After intensive policy discussions on coffee, in July 2008 a law was passed to replace the legislation, which had governed Ethiopia’s coffee auction since the 1960s. Henceforth, all Ethiopian coffee not directly exported by farmers would be traded not in the old auction, but rather on the Ethiopia Commodity Exchange.

It was not until 2010, that EXC returned to trading food grains in any significant volume when it negotiated an agreement with the World Food Programmed to buy maize through the exchange. The WFP is a major food buyer in Africa that normally dictates the terms of its purchases. However, the WFP had to bend its procurement policies in order to accommodate the non-tendered, open and transparent process of buying on an exchange-trading floor. In 2010 it made a promising restart with 6,000 tons of maize purchases.

Each decision to launch a new contract and thus enter a new commodity market is a strategic one, which affects the exchange in fundamental ways: in its revenues, in its political support, in its donor support and in the reputation and professional standing of its management.  Vested interests in each new market needed to be dealt with explicitly.

According to a report by Whitehead (2013), “Critics argue that markets in Ethiopia are still heavily disjointed, and that smallholder farmers cannot access the exchange. The model prevents traceability and is a poor market for highly differentiated products like coffee, which risk being standardized, they say. In London, the high-end coffee company Monmouth Coffee last year flagged up a concern with its Ethiopian offering: ‘As this coffee was bought and sold through the ECX, its traceability is limited… and full credit for the growing and preparation of the coffee cannot be given,’ it said in a promotional flyer. ‘We hope that at some stage in the future the Ethiopian coffee board will reconsider its current strategy and permit all coffees in Ethiopia to be traded directly.’

“Exchanges may make markets more efficient, but there is no differentiation, there is no sampling of the product, and the products traded are just not traceable,” argues Dirk Sickmuller, managing director of Taylor Winch Ltd, one of east Africa’s largest coffee brokers. “In this day and age the consumer wants to know what they are buying and where it has come from. In Kenya and Tanzania the coffees are fully traceable and we know exactly who is producing what, where, and when.” Whitehead (2013).

While it is sometimes argued that the ECX has promoted the welfare of coffee farmers as the value of exports has increased from $529 million in 2007 when the exchange was established to $797 million in 2012, others indicate that this rise can be almost totally explained by the increase in international coffee prices over this period. Moreover, recent analysis of ECX data indicate that the farmers’ share of the international coffee prices has not risen compared to pre-ECX farmer shares.14 ECX has apparently been unwilling to publicly share its data on prices received by farmers until quite recently, and has not accepted invitations by IFPRI and Oxford to carry out impact assessments on the ECX’s activities. Clearly more detailed assessments are necessary to understand how the ECX has affected the welfare of Ethiopian coffee producers.

In summary, Table 2 presents the status of all of the major commodity exchanges initiated in Sub-Saharan Africa in the past several decades and their current status. Three exchanges (SAFEX, ECX, and MACE) remain operational but only SAFEX is clearly sustainable and thriving based on the voluntary participation of all relevant market participants, and without significant external donor funding to sustain its operations. SAFEX’s unique situation is due in large part to its being able to satisfy the conditions all of the preconditions specified in Section 3.
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1 For an explanation of technical terms relevant to Commodity Exchanges, See Appendix 1 at page 27
13 Gabre-Madhin (2011)
14 For example, data from the International Coffee Organization indicates that farmers took home 51.6% of the export price of their product for the year ended September 2012, down from 57.1% in the year ended September 2007, before the exchange was established.

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FUNDING: The Indaba Agricultural Policy Research Institute is a non-profit company limited by guarantee and collaboratively works with public and private stakeholders. IAPRI exists to carry out agricultural policy research and outreach, serving the agricultural sector in Zambia so as to contribute to sustainable pro-poor agricultural development.

This report was commissioned by FoodTrade East and Southern Africa www.foodtradeesa.com, a 5-year trade enhancement and promotion programme focusing on staple food crops, funded by the UK Government. This report has been funded by UK Aid from the UK government; however the views expressed do not necessarily reflect the UK government's official policies.
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