LAUNCHING A SUCCESSFUL COMMODITY EXCHANGE IN TANZANIA. Godfrey Malekano, Director Market Supervision & Market Development-CMSA

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1 LAUNCHING A SUCCESSFUL COMMODITY EXCHANGE IN TANZANIA Godfrey Malekano, Director Market Supervision & Market Development-CMSA

2 The Role of Agriculture Agriculture is the backbone of the Tanzanian economy contributing about 26% of the National GDP 75% of the rural household income. 95% of the National Food requirement 70% of Tanzania population livelihood 30% of total exports 65% of the industries raw material requirements It mainly features small holders farmers Small holders farmers are not only central to food production, but also to poverty reduction At the same time, agriculture markets are highly ineficient Lack transparence system of price discovery and institution and instruments to manage risks 2

3 Tanzania Potential Vast untapped potential in agriculture, mining, and natural resources Growing domestic and Regional markets Abundant arable land Strong policy commitment to agricultural transformation- Hapa Kazitu Govt schemes like Kilimo Kwanza, SAGCOT, etc 3

4 What is a Commodity Exchange q A market in which multiple buyers and sellers trade commoditylinked standardised contracts on the basis of a legal framework and rules laid down by the exchange q Exchange does not deal with most of itsusers directly, but through Market Intermediaries. q Brokers post orders and also manage the related payment and information flows, as well as the delivery process. q The exchange is neither a broker nor a trader, but the market itself Thus, the exchange facilitates and guarantees transactions, but never takes ownership of any physical commodity q an exchange provides standard contracts, rather than letting buyers and sellers determine contract provisions. q Ensures and guarantees performance of each & every contracts traded on it s platform 4

5 Types of Commodity Contracts q Spot contract, spot transaction, or simply spot, is a contract of buying or selling a commodity for settlement (payment and delivery) on the spot date, which is normally two business days afterthe trade date. q Spot- a ready delivery market q Spot- Price discovery q Spot exchanges are simpler and easier to set. q Futures contract is a standardized contract that parties initially agree to buy and sell a commodity for a price agreed upon today with delivery and payment occurring at a future point, the delivery date. Futures contracts are traded on futures exchanges. q Futures- A deferred delivery market q Futures- Price discovery + Risk management q Futures exchanges a bit complex as they require hedgers, speculators, commodities with high price volatility, central counter parties etc 5

6 Electronic vs floor based exchange qelectronic tradingqnew world order qmore traders hence high liquidity qfloor basedqtraditional qsimple to establish q Challenges in outright electronicq The confidence of small holders q Market/technology literacy q Investment required q The infrastructure required q The IT network reach 6

7 Why Commodity Exchanges? Problems Coordination failure Fragmented mkts, many laws High transaction costs Markets are far from users Lack of standardized contract High contract risk Quality & quantity, delivery Location, time Information asymmetry High market risk Price uncertainities No efficient discovery Solutions Code of conduct Trading rules SROs Surveillance Government regulations Standardized contract Dispute settlement Settlement guarantee fund

8 Core Functions of a Commodity Exchange A reliable, efficient, and transparent means to connect many buyers and many sellers of storable, standardizable, and divisible assets Core Functions: Matching of trades Payment transfer Physical delivery Market information Dispute settlement

9 How it works a) Prices are determined solely by supply and demand conditions; b) Orders to buy or sell are channelled into the system by public (open) outcry or electronically rather than by private negotiation; c) Prices at which transactions are made are recorded and released publicly by the exchange as soon as possible- market transparency; d) The exchange has a clearing mechanism which ensures or guarantee that transactions undertaken by traders on the floor are honoured; e) Brokers bring and integrate large numbers of buyers and sellers; f) Exchange regulations and directives make it mandatory for members to make use of standard contracts prepared by the exchange; g) Members must adhere to the terms and conditions of the contracts and disciplinary rules of the exchange. 9

10 TMX Operations Flow: up to T FARMER/TRADER BRINGS COMMODITY TO TMX ACCREDITED WAREHOUSE BUYER MOVES FUNDS INTO PRE-TRADE ACCOUNT WORLD MARKET PRICE AND INFORMATION WAREHOUSE OPERATOR DOES GRADING AND WEIGHINGà WAREHOUSE RECEIPT TMX CENTRAL DEPOSITORY REGISTERS WAREHOUSE RECEIPT BUYER PLACES BUY ORDER WITH MEMBER ORDER MATCHING ENGINE SELLER PLACES SELL ORDER WITH MEMBER TRADE RECONCILIATION MARKET DATA SURVEILLANCE CLEARING SETTLEMENT DEPOSITOR PLEDGES RECEIPT FOR LOAN BANK UNPLEDGES RECEIPT FOR TRADING REPORTING 10

11 TMX Operations Flow: After T TMX CLEARING HOUSE ISSUES NET OBLIGATION TMX CLEARING ISSUES DEBIT INSTRUCTIONS TO SETTLEMENT BANKS TMX CLEARING DOES BALANCE ENQUIRY BUYER TAKES DELIVERY AT TMX WAREHOUSE TMX CENTRAL DEPOSITORY TRANSFERS TITLE TO WAREHOUSE RECEIPT TO BUYER TMX CLEARING ISSUES CREDIT INSTRUCTIONS TO SETTLEMENT BANKS WAREHOUSE OPERATOR ISSUES GOODS ISSUANCE NOTE TMX CENTRAL DEPOSITORY CLOSES WAREHOUSE RECEIPT

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13 What will it take? Critical mass of market actors Critical mass of commodity volumes trading Clear legal framework and appropriate regulatory environment Conducive policies Exchange Rules to guide the trading Internal monitoring and compliance enforcement Appropriate information technology 13 13

14 Pillars of an Exchange Legal and Regulatory Financial Systems Information Technology Infrastructure 14

15 Key to Success: Alignment Need 15

16 Toward the Right Solution: Lessons from the world 16

17 Global practices on: 17

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21 Benefits of Commodity Exchange q Exchanges provide market transparency q Bring the market closer to the farmers / producers q Exchanges provide price discovery q Exchange reduce transaction costs- brings markets closer q Reduce counterparty risk settlement is guaranteed q Provide information to policy makers, farmers and buyers on where supply/demand fundamentals are heading q Exchanges enable more efficient market behavior, e.g., storage, planting decisions, quality etc q Exchanges enable farmers & enterprises to manage risk q enable financial inclusion q Infrastructure enhancement 21

22 Who Benefits q Small holders farmers q Commercial farmers q Processors q Aggregators - cooperatives q Exporters q Lenders and financial service providers q Government produce cess and export levies due to trade data & transparency; q Economy as a whole more employment q Improvement of rural livelihood The hope behind all of these efforts is that small scale farmers will no longer be at the mercy of merchants in the nearest and only market that they know. 22

23 Tanzania Potential for a successful Exchange q The policy, legal and regulatory environment are encouraging; q Presence of Warehouse Receipt System and the law; q Abundance of arable land; q Macro economic stability; q modern telecommunication facilities; q financial sector infrastructure; RTGS, CSD, insurance, settlement banks; q presence of stable well educated urban professional class; q Regulatory structure for a sound commodity exchange q q Commodity exchanges Act, 2015 and Regulations Draft TMX Rules-trading, clearing and settlement, membership and dispute settlement. q Service providers in quality certification, transport, logistics, warehouse operators, market intelligence, etc q Presence of a securities market is a plus- same principles 23

24 ORGANIZATIONAL SET-UP OF THE EXCHANGE a) The TMX is a demutualized company formed under PPP framework. Public shareholders 49% and private shareholder 51%.. b) Initial shareholders are the Treasury Registrar, TIB Development Bank, PSPF and the Tanzania Federation of Cooperatives; c) Once the business plan is finalised, other investors will be invited. d) The Exchange will initially be a floor based. The commodity exchange needs to instill confidence in the smallholders farmers, who are more used to the system of auctions (Coffee) and will find the floor based system more appealing; e) The trading rights will be based on the type of membership; f) The Exchange will use a robust technology for integrating its operations; g) The exchange will begin with spot operations and add in futures and other derivative contract later; h) The exchange will develop a world class infrastructural facilities i.e. Exchange Application Software and telecommunication facilities and market dissemination system; 24

25 q The Exchange will initially be a floor based exchange. q The commodity exchange needs to instil confidence in the smallholders farmers, who are more used to the system of auctions (Coffee) and will find the floor based system more appealing. q The Exchange will use a robust technology for integrating its operations. q Over a period of about three years, the exchange will migrate to a wide area network to allow remote access. q The exchange will begin with spot operations. q The Exchange will also have a Settlement Guarantee Fund, which will increase in line with the volume of trading. q q TYPE OF THE EXCHANGE & CLEARING CYCLE TMX will strive to have a T+1 Clearing Cycle Presence of adequate risk containment provisions like, deposits, contribution by the trading/clearing members 25

26 COMMODITIES FOR TRADING During the initial phase of the exchange s operation, the exchange will trade a) Cashew Nuts b) Sunflower, c) Sesame seed and d) Rice (Paddy) a) the Exchange will add more commodities including metals as it grows because volume is key to itssuccess. Crop coverage of warehouse Receipt System will be key determinant. b) Before adding any commodity contract, crop feasibility study will be undertaken. 26

27 INFRASTRUCTURE & WAREHOUSING AND COLLATERAL MANAGEMENT q TMX will develop a world class infrastructural facilities, such as:- a) Trading Floor and office space; b) Exchange Application Software; c) telecommunication facilities; d) computer hardware and software for electronic and open outcry trading; and e) communication facilities to enable the fast transmission and dissemination of market data and other market information. q The Exchange will work with a network of warehouses operators; q q The warehouses will be selected based on the key aspects the catchment area of the warehouse in terms of the production and supply of the selected agricultural commodities. The warehouses will be owned by the private sector and operated as per the exchange structure. 27

28 ØExchanges are versatile instruments, capable of upgrading commodity sector performance in a range of situations and addressing emerging challenges as they arise Ø In general, exchange services are relevant for smallholders Ø however, price risk management is not always an important - or even relevant service - for smallholders compared with price information and physical market services Ø unless downstream partners are encouraged to pass on hedging benefits to smallholders Ø The exchange is not a panacea, and has depended on an appropriate regulatory environment and other complimentary policies and mechanisms ØEach country is different hence a different solution for each Conclusion " Almost all absurdity of conduct arises from the imitation of those we cannot resemble." Samuel Johnson, The Rambler, #135 28

29 Thank You 29