Keith Mukami, Director and Head of Africa: Banking & Regulatory at CMS South Africa, examines the benefits that commodity exchanges could bring to African commodity markets.
Commodity trading is key to Africa’s growth. After almost a decade of sluggish prices, we are witnessing strong growth in world commodity prices, notably in industrial metals, precious metals and energy, the top exports from Africa.
Commodity producers in Africa will expect to benefit from growth in export earnings over the next few years, with some commentators expecting 30% year-on-year growth in some commodities. That said, African commodity markets remain disorganised, unstable and inefficient. Most concerningly, the structure and pattern of Africa’s commodity trading does not appear to be changing. African exports baskets continue to be over reliant often on a single commodity and a lack of manufacturing activity. As a result, African economies were vastly affected by the commodity downswing as they will be by the surge in commodity prices that we are currently experiencing. Based on economic activity, there are arguably only a small number of economies that could be described as diversified. Whilst opportunities are opening (particularly for inter-regional trading through the African Continental Free Trade Area), these opportunities may take a while to be realised. This scenario has once again raised questions regarding the desirability and role that commodity exchanges could play to bring order to the markets.
The importance of commodity exchanges in the context of African trade was first mentioned in the Abuja Treaty of 1991, which established the African Economic Community (predecessor to the African Union).
“Commodity exchanges are highly efficient platforms for buyers and sellers to meet. They enable better and more transparent management of prices, whilst improving the marketing of physical commodities. They have significant and well documented developmental benefits, making economies more inclusive, boosting the links between agriculture and finance, and making the commodity sector more efficient and competitive.” (Guidebook on African Commodity and Derivatives Exchanges – African Development Bank, 2013).
A study conducted under the auspices of UNCTAD identified significant developmental benefits brought about by commodity exchanges. A comparative study examined the developmental impacts of commodity exchanges in Brazil, China, India, Malaysia and South Africa found evidence to support approximately 66 positive impacts that commodity exchanges offer (Development Impacts of Commodity Exchanges in Emerging Markets, Adam Gross and Leonela Santana-Boado, 2009).
The most important positive impacts can be summarised as follows:
Quick and easy dissemination of market prices and other information which would otherwise be difficult to access. Readily available price references can benefit market participants who are otherwise disconnected from the market and are vulnerable to inaccurate prices and conditions from better informed intermediaries. Information dissemination by an exchange can reduce the information asymmetries that privilege intermediaries and can empower participants to make better decisions in light of better understanding of market conditions. With reference to Ethiopia, The Economist (2007) noted how intermediaries’ margins plus other market failures add 20% to the cost of grain in Ethiopia. It argues: “Information, crucial to efficient trading, is scanty. But thanks to the impact of technology, things are improving. Mobile phones help farmers to find out about price discrepancies from which they might benefit. In some cases, better market information has managed to help farmers diversify their crops.”
This can be achieved without resorting to expensive technological solutions. In India for example, the national post office infrastructure delivers daily price information to villages and other small towns, which is then displayed on blackboards in prominent places. Once market participants are aware of prices, they are able to enter into more meaningful negotiations and make better informed judgement as to how to run their businesses.
A free and open auction system which ensures that market participants can sell goods closer to the market price, or even above it. This is another feature that assists market participants to make better informed decisions on future trading activities, such as where to invest their capital and how to diversify their sources of income.
The ability to reduce high transaction costs. By their very nature, commodity exchanges have the capacity to reduce high transaction costs in commodity value chains and thereby enhance efficiencies. Exchanges achieve this by offering services at lower cost than that which would be incurred by market participants acting outside the commodity exchange ‘ecosystem’. These can include the costs associated with finding a suitable buyer or seller, negotiating the terms and conditions of a contract, securing finance to fund a transaction, managing credit, cash and product transfers and arbitrating disputes between contractual counterparties. These benefits stimulate trade. It is for precisely these reasons that large commodity producing jurisdictions have embraced commodity exchanges and have benefitted greatly from their existence. In the past few decades, European and American exchanges have benefitted greatly by opening up to larger audiences, offering financial as well as commodity contracts and have not only stimulated agricultural growth but have also become very profitable in their own right. Commodity exchanges in some parts of Asia, notably India which is home to some of the largest exchanges in the world, have also followed suit. There is no reason why the same could not happen in African economies.
The opportunity to hedge against volatile prices on exchanges that trade derivatives, meaning that market participants can ‘lock in’ sale prices and benefit from price certainty. In the agricultural sector, it means that farmers can choose which crops are the most profitable to grow and judge the best time to sell in the market, minimising the risk of losing revenues as prices fluctuate.
Fewer risks to financiers who can use warehouse receipts as collateral that can be liquidated in the event of default. Traditionally, financiers have considered certain sectors in Africa as high risk and low profit business for standard modes of bank lending. As a consequence, many market participants in the commodity value chain pay disproportionately high levels of interest. Through commodity exchange ‘ecosystems’, forms of financing have been developed that can reduce financiers’ risk and costs of delivery by linking traditional financial tools with commodity exchange services.
Impetus to build better infrastructure. Exchanges can act as an impetus to create better infrastructure, such as warehouses and roads to transport product to market.
Boosting intra-regional trade. Africa is notorious for being one of the few continents where intra-regional trade is almost non-existent. Exchanges (particularly regional or continental ones) have the potential to boost intra-regional trade. Commodity trading in the context of the African Continental Free Trade Area (AfCFTA) have the potential to transform the face of commodity (and other) trading in Africa.
The AfCFTA is a trade agreement between 54 African Union member countries with the goal of creating a single market followed by free movement of trade and services, and a single currency union. If achieved, this regional organisation could become the world’s largest free trade area.
Commodity exchanges in Africa – past and future
Interestingly, Africa was home to one of the first exchanges in Alexandria, Egypt. This exchange was disbanded in 1961. The Alexandria Exchange not only played an important role in Africa but attracted participants from as far away as the US and India. In recent times, there has been a proliferation of initiatives across the length and breadth of the African continent, all aiming to establish commodity exchanges with the efficiency and scope of the Alexandria model.
It appears that African policymakers are increasingly embracing the idea of commodity exchanges as a catalyst for growth as well as for equitable, inclusive and sustainable development.
There has never been a better time to expand the number of commodity and derivatives exchanges across the continent. Key elements in establishing a sustainable exchange, such as the policy environment, rules relating to ownership of exchanges, better contract developments, as well as the creation of clearing guarantee structures, have evolved dramatically in recent years and offer the opportunity to create better organised commodity markets in Africa.
Notes
This article is based on research obtained in part from Development Impacts of Commodity Exchanges in Emerging Markets (Adam Gross and Leonela Santana-Boado, UNCTAD, 2009) as well as Guidebook on African Commodity and Derivatives Exchanges (African Development Bank Group, 2013).
The information held in this publication is for general purposes and guidance only and does not purport to constitute legal or professional advice.
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