COMMODITY EXCHANGES IN OTHER REGIONS OF THE DEVELOPING WORLD .

1. COMMODITY EXCHANGES IN OTHER REGIONS OF THE DEVELOPING WORLD. APBP 2005 Leonela Santana-Boado Senior Economist UNCTAD

2. OVERVIEW • The growing role of developing country exchanges • Exchanges in Asia-Pacific • Exchanges in Eastern Europe • Exchanges in Africa • Ways to improved efficiency • Conclusions

3. The growing role of developing country exchanges • Nowadays (and contrary to the situation five years ago), many of the world's largest commodity exchanges in terms of trading volumes are located in developing countries.

4. The growing role of developing country exchanges Most developing country exchanges, though, still operate with their hands tied behind their back: government policies now keep these exchanges essentially domestic; many of the exchanges are not allowed to introduce financial futures or even index futures (and this may well be where the largest growth potential is: worldwide, commodity futures account for less than a tenth of futures volume); and options are still not allowed in several countries. Once their shackles have been removed, these exchanges will grow even faster.

5. The growing role of developing country exchanges So far, only some of the smaller developing country commodity exchanges are open to international users – in particular, - The Malaysia Derivatives Exchange (MDEX) which trades a palm oil futures contract (the price reference for world palm oil trade); - The Bolsa de Mercadorias & Futuros in Brazil (small for its commodity contracts), which trades US$-denominated coffee, soybean, live cattle, feeder cattle, cotton, crystal sugar, corn and gold contacts; and - SAFEX, now a division of the Johannesburg Securities Exchange, which trades a range of agricultural contracts for the national and regional market.

6. The growing role of developing country exchanges • Developing country exchanges trade many of the same commodities available on western exchanges (e.g., copper, rice, soybeans), but also many commodities unique to the country. • The National Commodity and Derivatives Exchange-NCDEX-Mumbai), for example, has futures contracts in guar (a non-edible oilseed, and its largest success), yellow and lal tur (types of lentils) and cashew nuts. • The South African Futures Exchange (SAFEX) trades futures in sunflower seeds, and green beans are traded (albeit no longer very actively) in Zhengzhou.

7. Price Dissemination Discipline in the physical market The growing role of developing country exchanges But developing country exchanges are closer to their country’s farmers and have both an economic and a political incentive to stimulate producers’ hedging. Training NCDEX has installed price tickers, providing real-time price information in villages throughout the country, including in tribal regions. Strengthining of warehousing system NCDEX and the Multi-Commodity Exchange (MCX) are working around the problem by accrediting warehouses themselves.

8. The growing role of developing country exchangesStrengthening of warehousing system Farmer Exchange warehouse 1. Deposits products Commodity exchange 3. The highest bidder gets the products, and the farmer is paid 2. The warehouse receipt is (electronically) transferred to the exchange and auctioned off. Conditions: - the exchange either owns warehouses, or approves them - standardization of quality descriptions into specific grades, and - standardization of the documentation used.

9. Exchanges in Asia-Pacific Asian derivatives exchanges accounted for over 37% of the world’s derivatives trading volume in the first six months of 2004. Such rapid growth will probably continue and in a few years Asia is likely to account for the bulk of global derivatives trade.

10. Exchanges in Asia-PacificChina The DCE is the world’s largest soybean futures market. The soybean futures price in the DCE has become an important reference price for China’s soybean production and distribution and many international traders take the DCE soybean price as a benchmark. Some 110,000 users trade on the exchange.

11. Exchanges in Asia-Pacific: China - Zhengzhou Commodity Exchange (ZCE) ZCE was until recently trading in mungbean (green bean), small red bean and peanut kernel. In 2000, the Chinese regulatory body sought to stamp out attempted manipulations. As a result, mungbean and other commodity trading have virtually ceased. Cotton trading began in June 2004 and trading volumes have increased steadily each month. With the successful launch also of a second wheat contracts, ZCE is in effect a two-commodity exchange.

12. Exchanges in Asia-Pacific, China - Shanghai Futures Exchange (SHFE) SHFE was formed in 1999 after the merger of three exchanges: Shanghai Metal, Commodity, Cereals & Oils Exchanges. Futures contracts in copper, aluminium, natural rubber and fuel oil: plywood and long-grained rice contracts are under preparation. Trading in energy products was banned in 1994 after concerns about speculation, and has been slow to recover. 250 distant trading terminals connected by satellite

13. Exchanges in Asia-Pacific, China While NYMEX is still the world’s largest commodity exchange, in 2004, the three exchanges in China traded a total of 305.67 million contracts (with a notional value of 1.77 trillion US$),more than the 280.04 million commodity contracts for NYMEX, CBOT and NYBOT combined.

14. Exchanges in Asia-Pacific, Korea • In the first six months of 2004, Korea accounted for just over 80% of the total Asian futures and options trade. This figure is explained by the existence of KOSPI 200 Futures and Options. In that same month, all the KOSPI contracts plus single stock options were transferred from the Korean Stock Exchange (KSE) to the Korea Futures Exchange (KOFEX). • This move propelled KOFEX overnight from the 37th to the world’s most active derivatives market. • KSE does not trade commodity futures and while KOFEX lists gold, the trade is relatively minor. KOFEX has signed a MoU with the Tokyo Commodity Exchange and plans to diversify into energy products, with oil contracts aimed at small-scale hedgers such as local refineries and gasoline distributors. • In order to facilitate the diversification process and consolidate Korea’s regional standing, a KOFEX-KSE merger is under consideration.

15. Exchanges in Asia-Pacific, India • During the 1960s, the Indian Government either banned or suspended futures trading in most commodities. • The Government policy slackened in the late 1970s and trade in commodities futures was legalised fully in April 2003. • Options trade is still prohibited, however: no exchange or person can organise or enter into or make or perform options in goods. The market expects that the government will nonetheless permit options trading soon: the Rajya Sabha passed a Bill on options in the early part of 2004 although further development is still pending. • The Union Budget of 2004-5 is expected to further liberalise the position of commodity exchanges, allowing mutual funds and foreign institutional investors to participate in the commodity market; widening the definition of commodities to include also commodity indices and weather derivatives; changes in the Banking Regulation Act allowing banks to operate in the commodity exchanges; allow set-offs on trading losses in the derivatives market.

16. Exchanges in Asia-Pacific, India • With the establishment of National Multi-Commodity Exchanges in 2002/3, the Indian situation has changed dramatically. There are three such exchanges: NCDEX (started trading in December 2003; based in Mumbai), NMCE (Nov. 2002, Ahmedabad) and MCX (Nov. 2003, Mumbai). • The new exchanges are all demutualised, with permanent recognition to trade any permitted commodity. They have blazed a trail in the establishment of hi-tech, low-cost, web-based trading. This has contributed enormously to their rapid expansion. • National exchanges have also been credited with unilaterally introducing workable warehouse receipt systems, thereby improving the financial viability of India’s commodity trade.

17. Exchanges in Asia-Pacific,India Many of the contracts traded are unique to India; some are clearly domestic-oriented but others (such as precious metals, raw jute, pepper, grains and oilseeds) have the potential to take on international importance.

18. April 2004 to March 2005 trading volume of the commodity exchanges: more than 100 billion US$. • Will more than double in this year. • Expectation is that within 2-3 years, commodity futures trade volumes will exceed stock market volumes. • Why such a success? • One important reason was • a massive marketing • campaign. Brokers played • a key role in this.

19. One relevant experience: Indian exchanges have been willing and able to “fill the gaps” in the domestic commodity economy – e.g., weaknesses in warehousing infrastructure, or in legal systems. “PH Ravikumar, MD, NCDEX said India needed at least 1,000 warehouses, while only 150 warehouses were there. NCDEX started NCMSL early this year to facilitate physical delivery of exchange traded commodities. NCMSL already has close to 50 warehouse. Most of them are either leased or franchised, while rest are managed in association with government's warehouses.” (The Economic Times, India, 21 June 2005)

20. Another important lesson: nowadays, exchanges are to a large extent technology firms, instead of “logistics” firms. They need to have the management and financial capacity to invest in such technology and to roll it out, including to reach clients. E.g., in both Chinese and Indian exchanges, satellite-based connections played a large role, and the exchanges facilitated members’ procurement of VSATs (Very Small Aperture Terminals, satellite-receiving stations that cost around US$ 2000).

21. Exchanges in Asia-Pacific, Thailand The Agricultural Futures Exchange of Thailand (AFET) began operating in May 2004 and is the country’s sole commodity futures exchange, offering contracts in rubber and rice. Trading volumes have been slow to take off (it was only 120 million US$ in 2004). To address the situation the exchange in March 2005 introduced tapioca starch futures, and plans to introduce shrimp later in the year. It will also upgrade its technology so as to allow the participation of international investors.

22. Exchanges in Asia-Pacific, Malaysia Kuala Lumpur Commodity Exchange (KLCE) Commodity futures 1980 KLSE de-mutualised in 2004 and renamed itself Bursa Malaysia. In order to reflect its membership of the Group, MDEX today refers to itself as Bursa Malaysia Derivates. The stock and derivatives exchanges occupy the same premises. It offers eight futures contracts, including two commodity contracts. Kuala Lumpur Financial Futures Exchange (KLOFFE) 1995 Subsidiary Stock index futures Malaysia Monetary Exchange (MME) Interest rate futures 1996 1998 KLCE & MME merge into COMMEX 1999 KL Stock Exchange (KLSE) buys KLOFFE 2001 KLOFFE and COMMEX merge into Malaysia Derivatives Exchange (MDEX). Their clearing houses had already merged in 1997. Open outcry trading was stopped.

23. Exchanges in Asia-PacificSingapore • Singapore is home to the Singapore Exchange (SGX), formed in 1999 by the merger of two well-established exchanges, the Stock Exchange of Singapore (SES) and Singapore International Monetary Exchange (SIMEX). It trades about 31 million contracts; it concentrates on financial instruments. Its trade in commodity futures (fuels) is minimal, only a few thousand contracts a year. • A smaller exchange, the Singapore Commodity Exchange, offers rubber futures contracts and (without success) a robusta coffee futures contract.

24. Exchanges in Asia-PacificDubai (1) The Dubai Mercantile Exchange: Planned commodities: crude oil, natural gas, electricity futures and metals such as aluminium and (perhaps) gold. Planned start: mid-2006, with a sour crude futures.

25. Exchanges in Asia-PacificDubai (2) And a second project: the Dubai Gold and Commodity Exchange (DGCX), announced in November 2004. After establishing gold contracts, the exchange intends to cater to a significant amount of trade in silver, steel, freight, cotton and energy products. Planned start: last quarter of 2005.

26. Exchanges in Asia-PacificIran There are two planned futures exchanges in Iran. One for agricultural commodities (which has already started physical trade), one Euro-denominated for fuels and petrochemicals. The latter, of course, is not very popular with the US, and some US authors suggest it may be a reason for attacking Iran next.

27. Exchanges in Eastern EuropeHungary • The Budapest Commodity Exchange, created in 1989, which trades in financial futures as well as grains and livestock, has been quite successful. Nevertheless, its commodity futures volume has been falling in recent years, not just in relation to its financial futures but also in absolute terms.

28. ‘Exchanges in Eastern Europe’Romania • Romania’s Sibiu Monetary Financial and Commodities Exchange- founded in 1997-trades in futures contracts in foreing currency. • Romanian Commodities Exchange, opened in 1992, which also trades in grains and oil by-products.

29. ‘Exchanges in Eastern Europe’Poland • Warsaw Commodity Exchange, founded in 1995, deals in futures and options in agricultural products and currency. It is part of the Polish Commodity Exchange network, composed of 18 exchanges spread throughout the country.

30. ‘Exchanges in Eastern Europe’Russia • Moscow Commodity Exchange (MCE) created in late 1992, launched the first futures contract on US dollars. • Now, the fastest growing market is the new screen-based futures and options exchange FORTS – created in August 2001 after the merger of the derivatives division of the St. Petersburg stock exchange and the Moscow-based electronic stock market RTS (Russian Trading System).

31. Exchanges in EuropeTurkey • Around 20 of the existing exchanges are engaged in active commodity spot and to some extent, forward trade (others are called exchanges, but in fact, only act as centres for the registration of commodity trade transactions). The oldest, in Izmir, traces its origin back to 1891. • In 1997 the Istanbul Gold Exchange was launched to meet the demand for future gold products in Turkey. It was Turkey's first derivatives market, but remained largely inactive. • Early 2002, the Turkish Derivatives Exchange (TurkDex), headquartered in Izmir, was finally granted regulatory approval to introduce futures contracts. It started trading financial futures, cotton and wheat in February 2005.

32. ‘EXCHANGES IN AFRICA’South Africa • Africa’s most active and most important commodity exchange is the JSE Securities Exchange, South Africa that took over SAFEX in August 2001. SAFEX was formally established in 1988 and has been responsible for one of the leading emerging commodity markets. For a long time SAFEX only traded financial futures, but the creation of the Agricultural Markets Division in 1995 led to the introduction of a range of agricultural futures and options contracts for commodities. It now trades futures and options on white and yellow maize, bread milling wheat, sunflower seeds and more recently soya beans. • SAFEX trades an average of 100,000 tonnes of product daily and is widely recognised as the price discovery mechanism for maize in the Southern African region and as an efficient and effective price risk management facility for the grain industry. Its prices are quoted in several neighbouring countries.

33. OTHER EXCHANGES IN AFRICA Mostly, a story of failures, at times linked to government policies: • Alexandria’s Cotton Exchange, then 90 years old, was closed by Egypt’s Government in 1956. • Farmers established the Zimbabwe Agricultural Commodity Exchange (ZIMACE) in 1994, in response to the gradual liberalization of state-controlled agricultural marketing. The Exchange conducted spot and forward transactions and mostly handled agriculture produce, in particularly maize. A policy reversal led to a halt of the exchange’s operations. • The Zambia Agricultural Commodity Exchange (ACE), founded in 1994, conducted spot and forward transactions in wheat, maize and other agricultural products. The success of ACE led to the development of the Kapiri Commodity Exchange in Zambia’s central province and the Eastern Agricultural Commodity Exchange, in Zambia’s eastern province, both launched in 1997. However, policy reversals (government intervention in the maize market) led to the demise of the exchanges. • Nigeria’s Arusha Commodity Exchange was the result of the conversion by the Government of the Arusha Stock Exchange: trading software, staff training, everything was inappropriate…

34. But sometimes, a poor business model was to blame. E.g., • The Kenya Commodity Exchange (KACE) was set up in Nairobi in 1997, to provide the basic services of a commodity exchange. The products meant to be traded were agricultural commodities, like cereals, dairy products and cotton. In reality, trade has always been minimal. The exchange owners intelligently identified another potential flow of business, namely aid donors, and re-oriented the “exchange” to become a provider of paid-for price information. With donor funds, it is so far surviving. • Three different initiatives in Ghana never found sufficient business support • Similarly for a private-sector driven initiative in Nigeria • In Cote d’Ivoire, there is a “Bourse” for cocoa and coffee, but it has so far not managed to develop any real business. • Two different initiatives in Uganda, one with clear (vocal) government support, did not go to implementation. • Africanlion, a web-based coffee exchange, has not built up volumes.

35. Traditional problem: high set-up costs for a good system, but small economies make it impossible to recuperate costs. A new “franchising” model may well provide the solution.

36. Africa may go far with the creation of the Pan Africa Commodities and Derivatives Exchange (PACDEX). The national exchanges (all using the same common services) form part of a pan-African network, this would automatically link together country warehouses. This, in turn, can form the basis for intra-regional trade. Building an exchange in Africa Warehouses National exchanges tied into a pan-African network

37. ‘Ways to improve efficiency’ Creation of common platforms. MoUs Sharing of clearing platforms Sharing of trading platforms CBOT-DCE CME SHFE

38. Strategic alliances are crucial for the success of an exchange. For this to be possible, the exchange should represent the common interest, not narrow interests. In practice, those owning or controlling the exchange may be short-sighted, and opt for the safe and known strategy rather than opening up the exchange to wider interests. This has regularly led to the demise of exchanges – and is an important argument for demutualisation as a condition for the long-term success of an exchange.

39. ‘Ways to improve efficiency’ Consolidation of commodity exchanges within countries Mergers Sharing of trading platforms Sharing of clearing platforms

40. Ways to improve efficiency Demutualization Tendency to separate exchange management from direct ownership and trading interests (resulting in publicly listed, shareholder-owned companies with freely traded shares) appears to be motivated by self-regulation investor confidence concerns about good governance

41. Thank you