for standardised contracts for future delivery.
In other parts of the developing world, a commodity exchange may act in a broader range of ways, in order 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 for financing known as “repos”.
Alternatively, it may be through focusing on facilitative activities, rather than on the trade itself, as is the case in Turkey, where exchanges have served as centres for registering transactions for tax purposes.
By trading on a commodity exchange the benefits are numerous. There is an efficient price discovery mechanism since a commodity exchange is ideally bringing in large number of buyers and sellers.
Because of the laid-down rules and procedures which ensures a guaranteed settlement system it reduces price risks.
Deals are transparent in that prices are published and market information is available to all players.
Availability of rules of transacting across the exchange ensures the integrity of member companies and brokers is monitored.
The exchange system makes available a dispute settlement system through rules of arbitration, which offers a shorter route to the court system.
The exchange ensures maintenance of standards of quality of commodities and trading practices.
It also offers cost effective marketing system through transparent transaction costing and pricing of the commodities.
Commodity exchange contracts are signed by both parties and are legally binding hence there is security, certainty and transparency.
The contracts will cover, quality, quantity, passing of ownership and risk, price, payment terms, inspection, transport, delivery and weight, packaging, force majeure, demurrage, interest and arbitration.
The futures trading allow producers and buyers to offset the effects of adverse future price movements through transparent, standardised, and efficient hedging of agricultural commodity prices.
One of the primary functions of a commodity exchange is price discovery.
Price discovery refers to the mechanism through which prices come to reflect known information about the market.
The price level established on the open market can therefore represent an accurate depiction of the prevailing supply/demand situation in the underlying commodity markets, whether in the spot market for current deliveries or in the forwards/futures markets for deliveries at specified time and place.
Farmers are more likely to find a market for crops when true level of demand is reflected in the price signals.
Farmers become more informed about market and pricing information. There is improved received price from intermediaries because of authoritative and accurate reference price.
Cropping based on futures rather than spot price increases likely returns and facilitates crop diversification where farmers can better appreciate price, and ultimately income differentials.
It reduces intra-seasonal spot price volatility, increases returns to farmers as better enables them to hold until price level is good and empowers farmers as they can take more marketing decisions into their own hands.
The futures also take a price risk management function as it helps farmers to avoid serious losses when prices fall.
It enables farmers to receive a guaranteed price from a purchaser or intermediary and facilitates more effective planning and investment because of greater income predictability
Despite the above obvious advantages there are barriers that will hinder smallholder farmers from participating in a commodity exchange.
These include contract sizes that may far exceed the annual quantity of production those smallholder farmers are capable of; lack of knowledge, resources and capacity; infrastructure deficiencies; and cumbersome process of execution that may be beyond the farmer’s capacity.
Farmers may be able to break these barriers by participating through commodity associations or farmers’ associations who aggregate the hedging needs of several small-scale farmers and execute the trade on the exchange.
The association or farmers’ union can manage the positions in the market and liquidate the contract at an appropriate time
Warehouse Receipt System
The use of warehouse receipts system allows for farmers as individuals or groups to deposit their produce in registered warehouses thereby reducing post harvest storage losses and solving lack of storage challenges.
Warehouse receipts can be negotiable or transferable and used as collateral by smallholder farmers thereby improved access to finance.
Farmers are well informed of movements in the markets and are able to access markets rapidly, so they can wait to sell at the right time for the best price.
Market information and knowledge improves bargaining position for the farmers, create production incentives, and stimulate competition among the traders and matches supply and demand.
In Zimbabwe there is need for awareness and training and familiarity raising for the banking community on warehouse receipt systems.
Government’s objectives to intervene in markets are: to support prices and ensure food security.
These objectives can still be addressed as governments can accept warehouse receipts when prices drop below a support floor, rather than taking delivery of physical inventories.
Governments can achieve their food security objectives by merely holding these receipts.
For a commodity exchange to be successful there is need for policy consistence on agricultural marketing, that is there is need to perpetuate the market liberalisation policy.
Controls will literally make it impossible for a commodity exchange to operate.
The Zimbabwe Agricultural Commodity Exchange case was killed by lack of consistency in policy.
For Zimbabwe, it was from controls and then liberalisation during the Economic Structural Adjustment Programme era then back to controls post Esap to the present liberalisation of grain marketing. Thus we have gone full cycle regarding marketing policy.
In the region, there are examples of successful commodity exchanges including the South African Futures Exchange.
l Gift Mugano is an International Trade. He is studying for a PhD in Economics with Nelson Mandela Metropolitan University, SA. He is a Consultant and Programmes Director of Africa Economic Development Strategies. Feedback: [email protected], cell: +2778 017 4112