CHAPTER FIVE

AGRICULTURAL COMMODITY EXCHANGES

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 Introduction

 It is estimated that out of the roughly 2.5 billion people engaged

in agriculture in developing countries, about one billion derive a
substantive part of their income from export commodities.

 For many developing countries, commodities remain the

backbone of their economies.

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 Cont’d

 Approximately half of the countries in Africa derive over

80 percent of their merchandise export income from
commodities.

 In particular the economies of the least developed

countries are based on commodities which represent about
70 percent of their total merchandise exports.

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 What is a commodity exchange?

A commodity exchange is a market in which multiple buyers and

sellers trade commodity-linked contracts on the basis of rules and
procedures laid down by the exchange.

In developed countries, and in an increasing number of

developing countries, such exchanges typically act as a platform
for trade in futures contracts, or for standardized contracts for
future delivery.

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 Cont’d

• 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 for financing (known as
“repos”).

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 Cont’d

Why is a commodity exchange useful? What functions does it perform?

The usefulness of a commodity exchange lies in its institutional

capacity to remove or reduce the high transaction costs often faced
by entities along commodity supply chains in developing countries.

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 Cont’d

• A commodity exchange reduces transaction costs by offering

services at a lower cost than that which participants in the
commodity sectors would incur.

• commodity exchanges can promote more efficient production,

storage, marketing, and agro-processing operations, and improve
overall agriculture sector performance.

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 Commodity exchanges and regulation

Trade-facilitating institutions boost trade by reducing the cost and

the uncertainty of entering into transactions.

As has been detailed by UNCTAD (1997), beyond basic oversight

to ensure auctions are open and not manipulated, there are two
important thresholds at which the regulatory framework becomes
an important foundation for commodity exchange activities.

The first is when an exchange moves from trading products that

are physically present at its premises to trading paper which
represents the right to commodities.
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 Cont’d

These rights need to be enforceable, and this is achieved

through the clear definition of contractual rights and

obligations arising from transactions conducted in the

exchange, and of the mechanisms that enforce them.

A second threshold occurs when intermediaries start to play

a role in the market on behalf of end users;

the activities of these intermediaries need to be overseen to

ensure that they fulfill obligations.

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 Cont’d

According to the “Objectives and Principles of Securities

Regulation” (International Organization of Securities Commissions,
regulation has three overarching objectives:

Protection of investors: measures taken to protect investors –

taken here to mean all market users – from unscrupulous or
irresponsible practices by the exchanges, counterparties, or
intermediaries that they may interact with.

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 Cont’d

Common mechanisms used to protect investors include

fitness or good character qualifications for intermediaries;
requirements for intermediaries to segregate client funds
from their own funds; and binding arbitration mechanisms
for dispute settlement.

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 Cont’d

• Ensuring that markets are fair, efficient, and transparent:

measures taken to ensure that the market price truly reflects
the information known about the market, to constrain
“speculative excess”, and to avoid manipulation of prices or
physical stocks.

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 Cont’d

Reduction of systemic risk: measures taken to effectively manage

the systemic risk arising from market operations, reducing the risk of
default to acceptable levels

Common mechanisms used to reduce systemic risk include:

minimum capital requirements in order to participate in the markets;

 the rigorous use of the margining system, with margin levels related
to market risk

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 Cont’d

daily price movement limits that confine daily trading within

defined price parameters;

and a “risk hierarchy”, which ensures that exchange

members cover their clients’ positions in the case of a client
default and a clearing-house guarantee fund covers members’
positions in the case of a member default.

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 Cont’d

• In a mature structure, regulatory oversight – fulfilling each of the

three objectives outlined above – can exist at three levels:

External regulator

a governmental agency, or an independent agency accountable to

Government, that provides regulatory oversight across national
markets as a whole.

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 Cont’d

The exchange as a self-regulatory organization

the exchange’s own personnel and systems that provide

regulatory oversight over exchange operations, including both the
trading and where it is performed in-house the clearing and
settlement functions.

The industry’s self-regulatory organization

a body that either represents market intermediaries or is

appointed by the Government to oversee the activities of market
intermediaries.
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 The Ethiopia Commodity Exchange (ECX)

 The Ethiopia Commodity Exchange (ECX) is a new initiative for

Ethiopia and the first of its kind in Africa.

 The vision of ECX is to revolutionize Ethiopia’s tradition-bound

agriculture by creating a new marketplace that serves all market
actors, from farmers to traders to processors to exporters to
consumers.

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 Cont’d

 ECX represents the future of Ethiopia, bringing integrity,

security, and efficiency to the market.

 ECX creates opportunities for unparalleled growth in the

commodity sector and linked industries, such as transport and
logistics, banking and financial services, and others.

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 Cont’d

• ECX assures all commodity market players the security they

need in the market by providing a secure and reliable End-to-
End system for handling, grading, and storing commodities,
matching offers and bids for commodity transactions, and a
risk-free payment and goods delivery system to settle
transactions while serving all fairly and efficiently.

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 Cont’d

• ECX creates trust and transparency through aggressive market

data dissemination to all market actors, through clearly defined
rules of trading, warehousing, payments, and delivery and
business conduct, and through an internal dispute settlement
mechanism.

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 Cont’d

• ECX provides market integrity at three important levels: the integrity

of the product itself, the integrity of the transaction, and the integrity
of the market actors.

• The Ethiopia Commodity Exchange (ECX) commenced trading

operations in April 2008.

• ECX has invited members of the agricultural and trade industry.

• The Ethiopian Commodity Exchange was started to benefit and

modernize the way Ethiopia was trading its most valuable assets, its
commodities
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 Cont’d

• Ethiopia needed a change from the traditional means of trading to

better support the needs of all those involved in trading and
production.

• With only one-third of output reaching the market, commodity

buyers and sellers tended to trade only with those they knew, to
avoid the risk of being cheated or defaulting.

• Trade is done on the basis of visual inspection because there was no

assurance of product quality or quantity, this drove up market costs,
leading to high consumer prices.
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 Cont’d

• ECX is developing a new method of exchange and a safer one for all
who trade on it.

• A marketing system that coordinates better, links faster and protects

the interests of both sides of the trade.

• It is time for a marketing system that is transparent, efficient, and

innovative, that will take Ethiopian agriculture into the new
Millennium.

• The Ethiopia Commodity Exchange, (ECX), is a marketplace, where

buyers and sellers come together to trade, assured of quality,
delivery, and payment.
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 Cont’d

• The vision of ECX is to transform the Ethiopian economy by

becoming a global commodity market of choice.

• ECX’s mission is to connect all buyers and sellers in an

efficient, reliable, and transparent market by harnessing
innovation and technology, and based on continuous
learning, fairness, and commitment to excellence

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 Mission and Vision 

• Vision: To transform the Ethiopian economy by becoming a global

commodity market by choice.

• Mission: This is to connect all buyers and sellers in an efficient,

reliable, and transparent market by harnessing innovation and
technology based on continuous learning, fairness, and commitment
to excellence.

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 Agricultural Marketing Features Prior to ECX

• Lack of order in the market and its actors,

• Lack of integrity in the market actors, product, and

transaction,

• Lack of transparency in the trading system,

• Limited efficiency in the market,

• Low farmer empowerment and price bargaining power,

• Limited awareness and market information.

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 Cont’d

The debate about commodity-price volatility and appropriate policy responses

•Historically, unfavorable movements in world commodity prices have

impeded development in the developing world.

•Two distinct tendencies have been noted.

•Firstly, commodity prices have often exhibited sharp volatility in the

short run, with significant year-to-year variability.

•Secondly, there has been a long-run decline in commodity prices, both

in absolute terms and relative to prices of manufacturing and services.

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 Cont’d

• The effects of these tendencies have been felt in developing

countries both at the macro and the micro level.

• Governments seeking to maintain low and stable domestic prices for

these commodities may face increased pressure on their budgets,

resources may need to be diverted from other important areas of

spending, and levels of overall indebtedness may increase.

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 Dealing with commodity-price volatility: policy
options for commodity income stabilization

• Diversification strategies

• Reducing dependence on limited and volatile income streams, by

diversifying into new crops with unrelated price development.

• Supply management

• Controlling the supply of a commodity relative to demand, in an

attempt to influence the price.

• National revenue management

• Budgetary management designed to smooth government expenditure

over time, via stabilization funds and spending rules. 29
 Cont’d

Compensatory finance:

• Relief loans or payments to countries triggered by falls in

commodity export revenues.

Market-based risk management instruments:

• Instruments used to offset exposure to price risk through

financial markets or other institutions

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 Commodity-linked contracts

Spot (or cash): Contracts for the purchase or sale of a

commodity with immediate delivery (i.e. within a few days).

Forwards: Contracts for the purchase or sale of a

commodity with deferred delivery.

Futures: Standardized forward contracts which represent an

obligation to make or take delivery of a fixed quantity and
quality of a commodity at a specific location.

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 Cont’d

Options: Contracts giving the right, but not the

obligation, to buy or sell a futures contract at a specified
price or before a specified date.

To obtain such a contract, the buyer needs to pay a

premium the maximum loss is limited to this premium.

Swaps: An exchange of specified future payment

streams between two counterparties.
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