Emerging commodity exchanges UNCTAD, Commodities Branch Olivier Combe, Lamon Rutten, Leonela Santana-Boado

When is it useful to start the creation of a commodity exchange?

What does an exchange provide? Transparency in prices Everybody can know at what price is each product sold Avoid manipulation, provide a benchmark price for transaction Reduces cost transaction Everybody is in the same place, no need to look for buyer or seller Provides price discovery What will be the price of Robusta coffee next month? Sorry, I only deal with love affairs, look at the commodity exchange

Buyer B u y e r Seller S e l l e r Why Have a Commodity Exchange? Reduce counterparty risk. It’s the most competitive trading mechanism available It gives a competitive price quote Increases sources of finance Allows price risk management Reduce counterparty risk. It’s the most competitive trading mechanism available It gives a competitive price quote Increases sources of finance Allows price risk management Through the exchange

The development of a commodity exchange; preconditions A real willingness from politicians A sound legal framework Sound infrastructures A real interest from exporters, traders and producers I will reach it C o m m o d i t y E x c h a n g e

The development of a commodity exchange; settings And now our daily report on wood prices quoted at the exchange Availability of information through medias Building settings Clearing house floor Telecommunications between traders and the trade floor Trade floor Brokers ’ floor controls Law modification Allow the existence of the exchange and its practices, provide incentives to deal in the exchange

What would be the components of a detailed action planNecessary infrastructure:  trading room  many telephones  weighting and quality control equipment  a system to record prices Trading rules: choose the right language for the orders  best bid/offer should be automatically accepted register the deal immediately on standard form Need to be trained:  those active on the exchange  exchange officials  exchange users outside the exchange  create some awareness among local bureaucrats and politicians Contract formulation including:  the minimum quality acceptable  discount or premium if quality is lower or higher  traded quantity  delivery conditions  procedures to follow in case of dispute Exchange organization / rules to determine:  formal criteria for access  financial guarantee  which staff  the trading period

Operating systems; telecommunication costs Buyers and sellers interconnected through a computer network More adapted to risk-management Easy to add new products; long trading hours; perfect recording of operations Buyers and sellers are dispersed It’s a centralized trading floor, with buyers’ and sellers’ representatives It’s a centralized trading floor, with buyers’ and sellers’ representatives What Why Whe re Costs Advantages More adapted to physical trade More adapted to physical trade Buyers and sellers need to be in one place Buyers and sellers need to be in one place Physical infrastructures; relocation Physical infrastructures; relocation Role for locals; low risk of breakdown Role for locals; low risk of breakdown Open-outcry versus Electronic trade

Steps of development Traders Producers Foreign traders 1 Easier to deal first only on physical goods Producers may come with warehouse receipts or with samples T r a d e r s m a y t r a d e w i t h s p o t o r f o r w a r d c o n t r a c t s, t h e y m a y c h o o s e t h e g o o d s F o r e i g n t r a d e r s m a y d i r e c t l y n e g o t i a t e w i t h p r o d u c e r s, t h e y m a y t r a d e w i t h s p o t o r f o r w a r d c o n t r a c t s Learning stage of trading mechanisms, most trades are spot, some are over-the-counter

Steps of development C O N T R A C T - facilitate planning and marketing - lock in forward prices - secure a processing margin Advantages - tailor made - ensures physical market for the commodities produced - can make production or pre-export finance possible Disadvantages - difficult to revert initial decision - major counterparty risk - possibility of profiting favourable spot market developments is lost 2 Creation of contracts Purpose

Steps of development 3 Creation of a new futures exchange The underlying product should really be different from already traded ones in other futures markets (problem of basic risk) The volume of traded contracts should be sufficient (problem of liquidity) The futures contracts will be more successful when located in a region which is an important producer

Public Brokers Clear brokers’ accounts Clearing house Market floor Trade according to their client’s mandate Control trades and prices Give mandates of purchases and sales Convey orders from the clearing house Public is: -speculators -bodies which hedge -arbitrager Roles of equal significance Counterparty risk is absent from futures market Example of a futures market and its components

Steps of development C O N T R A C T - hedge price risk - lock in the value of inventories or finance part of storage costs - secure a processing margin Advantages - no need to negotiate contract specifications - minimal counterparty risk - initial position can easily be reversed - delivery is not necessarily implied Disadvantages - working capital is frozen up in margins - possibility of profiting from favourable spot market development is lost - prices of the hedged product and the futures contract may diverge 3 Creation of contracts Purpose

Steps of development - obtain protection against unfavourable price movements while retaining the possibility of benefiting from favourable ones - valorize inventories Advantages - available in standardized form on exchanges, and tailor-made over-the-counter - no “funding risk”: the costs of protection are known up-front - possibility of benefiting from favourable price movement Disadvantages - up-frpnt premiums can be expensive, especially in times of volatile prices - selling options can be highly risky - options sellers need to pay margin calls 4 Creation of contracts Purpose

Roles of Government and International Organisations Tax speculation and hedging differently Do not change price policy too often In building infrastructure In providing training and spreading information For reliable quality specifications and warehouse receipts For reliable trading system, prices, contracts, brokers and traders In the design of contracts Motivate producers to deal through the exchange Arrange that quotas for low-tariff entry of selected products into other countries are traded through the exchange

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