Establishment of Commodity Exchange in Bangladesh-Opportunities, Challenges, Limitations and Solutions

1???????Preface

A commodity exchange is a system of legal framework where various commodities are traded, with rules and procedures for trading standardized commodity contracts and related investment products. The transactions take place either on paper or electronically. The product remains in a shop, warehouse, or field. From there, it is finally disposed of or handed over after a certain time. At present, commodity exchange is being used globally as a technique to mitigate the risk faced by the producers of agricultural commodities. Experts believe that the establishment of commodity exchange markets in Bangladesh also might be an effective tool to address the problems like the poor state of rural market infrastructure; market imperfections, and the absence of risk-minimizing instruments.

2???????Objectives of The Report

The basic purpose of this study is to analyze the performance of well-established commodity exchange markets of India and Ethiopia, and other recently developed commodity exchange markets of Nepal, Pakistan, and four African countries. This analysis will help to explore the significance of having a commodity exchange in Bangladesh and identify the prerequisites for implementing such in our country.

3???????Limitations of The Report

Prepared the report based on the report of different commodity Exchanges, however, a physical visit is required to understand the actual structure of Commodity Exchange.

4???????Definition of 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. It typically acts as a platform for trade in futures contracts, or for standardized contracts for future delivery. It may also stimulate the trade of commodities in different ways. 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).

5???????Establishment of Commodity Exchange in Bangladesh

At present, commodity exchange is being used globally as a technique to mitigate the risk faced by the producers of agricultural commodities. Experts believe that the establishment of commodity exchange markets in Bangladesh also might be an effective tool to address the problems like the poor state of rural market infrastructure; market imperfections, and the absence of risk-minimizing instruments. It is high time to establish a commodity exchange in Bangladesh to ensure the efficient price of the commodities. A commodity exchange is a system of legal framework where various commodities are traded, with rules and procedures for trading standardized commodity contracts and related investment products. The transactions take place either on paper or electronically. The product remains in a shop, warehouse, or field. From there, it is finally disposed of or handed over after a certain time. It was observed that prices of commodities are not fair due to unfair prices faced by the farmers, a significant gap between wholesalers ‘and retailers ‘prices, low productivity, and lack of rural development. Considering the issues, existing Stock Exchange(s) may establish a commodity exchange to provide fair and efficient prices of commodities for consumers and retailers.

To determine the prospects of commodity exchange in Bangladesh, the commodity exchanges of different countries were reviewed. Among them, some may be identified as successful in terms of their performance and the role they played in their economy. But some commodity exchanges have failed to fulfill their objectives mainly due to their inefficiency, lack of regulations, infrastructure facilities, resources, and lack of awareness among the stakeholders.

6???????Brief Overview of the Commodity Exchanges in Different Countries

The brief overview of the commodity exchanges in different countries will be helpful to get an idea about the roles played by the exchanges and the problems faced by them so far. We have provided the highlights of some commodity exchanges as follows:

6.1??????Commodity Exchange Market in India

India is an agriculture-based economy. It is the fifth-largest producer of agricultural commodities in the world. Two-thirds of its total population depends on agriculture. This sector accounts for not only about 10% of the country ‘s total export earnings but it also provides raw materials to a large number of industries. Having the third largest agricultural land in the world it is the top producer of many agriculture commodities. Multi Commodity Exchange of India Ltd (MCX) (BSE: 534091) is the first commodity exchange based in India and was established in 2003. Indian commodity market performs significant economic functions of price discovery and price risk management. It is beneficial for farmers, consumers, traders, and the economy. It provides advance price signals to sellers (farmers/producers) and assists buyers (consumers) of agricultural commodities in financing commodities from one season to another. The commodity markets in India has achieved substantial development in term of transparency, technology, and trading activities though the production, supply, and distribution of many agricultural commodities are still governed by the state, and the forwards and futures trading are selectively introduced with stringent controls. At present, they have Bullion, base metals, Energy, and Agri-Commodities in the Commodity Exchange.

6.2??????Commodity Exchange Market in Pakistan

Pakistan Mercantile Exchange (PMEX) is the first and only technology-driven, web-based commodities exchange in Pakistan. It started in May 2007 as a fully electronic exchange with nationwide reach. Its vision is to bring international markets to a domestic platform and to provide its domestic markets a gateway to international cotton, rice, wheat, and sugar markets. The purpose is to provide a platform for retail investors, corporations, farmers, millers, and hedgers to make use of price discovery and price risk management according to their needs. PMEX does this by providing its target audience with a legal, regulated, and transparent 21-hour operational market for trading and investing in commodity futures. now they have –Metal (gold, silver, Copper, Platinum Palladium), Energy (Crude Oil, Brent Crude Oil, Natural Gas), Agriculture (Cotton, Wheat, Corn, Soybean), Energy Index and Liquid Contracts, etc.

6.3??????Commodity Exchange Market in Kenya

The Kenya Agricultural Commodity Exchange (KACE) collects prices and traded volumes of a wide range of products from nine wholesale markets and disseminates them using Radio, SMS, interactive voice response service (IVRS), Internet and email. The operators admit that by only providing prices, systems are of little value and it cannot be recognized as a commodity exchange. The initial idea of the exchange was to invite buyers and sellers to its trading floor to do business or to link them electronically. Although it also offers to help clients put their deals together, not enough people have taken advantage of this service to make it viable. They have a warehouse receipt service which is based on three warehouses, one having a 10,000-ton capacity and two others of 1,500 to 3,000 tons each, owned by a private operator who will offer public storage.

7???????Necessity of Commodity Exchange in Bangladesh

It is evident that problems faced by the farmers result in the growing need for a commodity exchange in Bangladesh. Through the exchange, the farmers or producers will be able to discover fair prices and the consumers or investment companies will purchase commodities by providing fair prices to them. By taking positions in commodity contracts the producers can effectively lock in the price at which they wish to sell their produced commodity. Selling commodity futures contracts can give them assured demand at the time of harvest. The commodity markets in India are operating successfully with six national and sixteen regional commodity-specific exchanges, which regulate the forward trading of 113 commodities. It performs significant economic functions of price discovery and price risk management. Transparency, well-designed technology, and organized trading activities are identified as the major forces behind their success.

The establishment of a commodity exchange market in Bangladesh will open up a new door of opportunity for farmers/producers. Through this exchange market, they will be able to reduce the financial loss which they face every year due to a mismatch between supply and demand during peak season. The commodity exchange market will provide advance price signals to sellers (farmers/producers) and will assist buyers (consumers) of agricultural commodities for financing commodities from one season to another. The opportunity for future selling will also encourage them to deliver quality commodities to the buyers. By analyzing the performance of the commodity exchange market of our neighboring countries like India, Nepal, and Pakistan it has been found that they are positively contributing to the economy. Lack of infrastructure facilities, poor awareness among stakeholders, and weakness of regulations are the main reasons for not attaining the expected benefits from some exchanges. Despite multiple challenges and drawbacks, commodity exchange markets would be quite successful in making a significant positive contribution to the economy.?

8???????Regulatory Framework in Bangladesh

At present, there is no separate regulatory framework for the formation of a Commodity Exchange in Bangladesh. However, it is stated in the Section-2(ccc) of the Securities and Exchange Ordinance, 1969, regarding commodity future contracts, read as follows:

(ccc) “Commodity Futures Contract” means an agreement to purchase or sell a particular commodity for delivery or settlement in the future at a price to be determined by a contract that obligates each party to fulfill the contract at the specified price and that may be settled by delivery, cash or offset at the Commodity Exchange duly registered with the Commission and in relation to Commodity Futures for the expression “commodity” includes,-

??????i.?????????agricultural, livestock, fishery, forestry, mining or energy goods, and any product that is manufactured or processed from any such goods; and

????ii.??????????any other matter as may be notified by the Commission in the official gazette;

Exchange regulators have a double responsibility. The first one is to ensure the safety and soundness of the commodity exchange system. This encompasses four elements:

1.????Market integrity regulation: to ensure that the prices on the exchange properly reflect the supply and demand conditions of the underlying physical (or asset) markets.

2.????Prudential regulation: to ensure that commodity exchanges and the other parties that form part of the exchange system (brokers, clearing banks, etc.) are financially sound and able to meet their market obligations. This includes capital rules, internal controls, qualifications of key staff, inspections, etc. The regulatory process should also provide the regulator with the information necessary to identify potential problems early on.

3.????Business conduct regulations: to protect consumers, especially retail clients. This includes risk disclosures, staff training requirements, etc.

4.????Market stability protection: ensuring that commodity exchanges and related parties do not cause a systemic risk for the rest of the economy. The exchange regulator may share this responsibility with the Central Bank.

The conditions to be met by successful applicants to a request for expression of interest would in particular include the following:

• The proposal needs to contain a sound argument on how diverse interests – growers, processors, exporters, importers, speculators, brokers, and banks –will be attracted to the exchange.
• The exchange should envisage the creation of an online system of trading.
• The proposal needs to provide efficient clearing, settlement, and guarantee systems.
• The promoters should provide an action plan under which delivery of commodities on the exchange will be through a, preferably electronic, warehouse receipt system;
• The proposal has to set out in a convincing manner how a system of well-organized and capitalized brokerage houses will be created.
• The proposal has to detail the planned arrangements for real-time price and trade information dissemination.
• The promoters need to plan for transparency in operations and decision-making.
• The proposed exchange has to have reliable, effective, and impartial management, and preferably demutualized form of organization.

9???????Overview of Regulatory Responsibilities of Exchanges and Regulatory Agencies

9.1 Regulatory and General Overview

Exchange licensing

• Provide licenses to exchange initiatives that meet the conditions set out on an invitation for Expression of Interest, and then give a permanent license to those that implement
• promised systems and practices within the set deadline

Process of developing rules and regulations

• Develop rules and regulations for approval by the Bangladesh Securities and Exchange Commission
• Fully accept the role of exchange as a front-line regulator, and give it the powers thus required;
• Work closely together with exchange initiatives to develop the details of laws and regulations, for the exchange itself as well as for warehouse receipt systems

Market integrity

• Ensure proper performance of the delivery process, including supervision over warehouses that act as delivery points;
• ?Design strong contract specifications;
• ?Supervise market performance, in terms of logical behavior of prices;
• Monitor against manipulation attempts;
• Take action against manipulation attempts;
• Ensure a level playing field for all participants.
• Scrutinize contract proposals made by exchanges to ensure they are sufficiently safe from manipulation attempts;
• Continuously analyze markets and prices, and in case of problems, instruct the exchange to intervene when the exchange fails to do so;
• Work with exchange to ensure a level playing field

Prudential regulation

• Set net worth and other criteria for exchange brokers;
• Coordination with other financial regulators to ensure bans on improper brokers are enforced across financial markets;
• Introduction of a settlement guarantee fund.
• Regularly verify adherence of brokers to these criteria, including by surprise audits.

Client protection

• Formulate, implement, and enforce a wide range of client protection rules and regulations;?
• Scrutinize detailed trade data to detect potential client abuses;
• Supervise the handling of the customer complaint process (if not handled by a self-regulatory brokerage association).
• Scrutinize the manner in which the exchange handles the analysis of detailed trade data.
• Oversee handling by exchange of the customer complaint process.
• Introduction of a customer protection fund;
• Work with other authorities to combat bucket shops.

Protecting the stability of the financial system

• Ensure proper operation of the clearing and settlement process
• Understand clearing arrangements, and properly supervise the exchange’s clearinghouse;
• Coordinate market stability protection measures with the Central Bank;
• Coordinate with foreign regulators.

Market promotion/ advocacy

• Fully acknowledge the role of promoter of the exchange initiative(s);??
• Interact with other government departments to develop new laws and to ensure rules and regulations are harmonized in a manner favorable to exchanges.

?9.2 Forms of Exchange

The existing Stock Exchange(s) may introduce Commodity exchange through the format of a separate Board i.e. Commodity Board like Main Board, SME Board, or ATB Board, or establish a separate subsidiary company for Commodity Exchange.

10???Benefits from Commodity Exchange

The study also highlighted several benefits of establishing a commodity exchange which include:

• Reducing costs of production, transportation, and storage;
• Providing safety to smallholder farmers by collecting, classifying, and pricing their products in a transparent way that will enhance the marketability and quality of their produce;
• Eliminating many of the bottlenecks across the value chain and reducing losses and waste;
• Ensuring an organized market of traded commodities that will help policymakers to better evaluate food availability, access, and utilization;
• Establishing more qualified warehouses, crop collection centers, and logistic hubs that would link to the exchange and gradually bring the informal trading sector into a formal one.
• The Exchange is expected to provide greater stability whenever there are commodity price fluctuations by reducing risk and increasing the number of traders, trade volume, and trade value, and enhancing overall product quality. This will increase trade effectiveness and promote efficiencies that will result in higher income for small-scale farmers, and consumers will have access to higher quality and affordable goods. This commodity exchange can also act as a vehicle to create new ideas and innovations across the food value chains, thus attracting new investments into the agro-food sector.
• The exchange provides a transparent pricing mechanism that enhances the volume of transactions. This attracts more investment into commodities, leading to a multiplier effect on the economy. The standardized contract terms, guarantee performance by all parties and thus serve as a safe and profitable investment outlet in the economy

11???Challenges in Agriculture Sector

There is a multitude of challenges constraining the development of Commodity Exchange in Bangladesh, which include not limited to:

• Inadequate infrastructure for efficient agricultural marketing
• Distance to markets, especially during rainy seasons?
• Limited access to and poor quality of marketing service provision
• Reliance of smallholder farmers on selling to intermediary traders below minimum farm gate prices
• Policy incoherence that negatively affects marketing
• Inadequate access to credit for smallholder farmers
• Small farm sizes
• Excessive climate risk
• Lack of reliable or formal market access - reliance on informal rural intermediary vendors that set prices, where farmers have little bargaining power.
• Low literacy rates, including financial literacy
• Dominant informal marketing system for most crops
• Poor implementation of market regulatory frameworks
• Lack of market information/information asymmetry and
• Disorganization of farmers

12??Prerequisites for a Commodity Exchange Market in Bangladesh

Analysis of different commodity exchanges across the world has given the idea about the success factors. The inadequacy of these factors has made many commodity exchanges fail or delay getting a positive outcome.?To achieve the expected result, the proposed commodity exchange should fulfill the following prerequisites:

12.1??Warehouses for Physical Delivery/Settlement

The physical settlement involves the physical delivery of the underlying commodity, typically at a certified warehouse. The seller intending to make delivery would have to take the commodities to the designated warehouse and the buyer intending to take delivery would have to go to the designated warehouse and pick up the commodity. The efficacy of the commodities settlements depends on the warehousing system available. Most international commodity exchanges used certified warehouses (CWH) for the purpose of handling physical settlements. So to provide a platform for futures trading of agricultural commodities, and also of non agricultural commodities, the exchange market will require a large number of warehouses.?CWHs are required to provide storage facilities for participants in the commodities markets and to certify the quantity and quality of the underlying commodity. Another advantage of this system is that a warehouse receipt may act as good collateral. Warehouse receipts will be given to ensure ownership of commodities that are stored in a warehouse. They will also act as indicators of ownership for inventory goods and/or unfinished goods stored in a warehouse by a manufacturer or distributor. Government-controlled warehouses can be the major providers of agricultural produce storage facilities.

12.2??Institute for Quality Assurance: Grading and Standardization

Commodity derivatives demand good standards and quality assurance/certification procedures. A good grading system allows commodities to be traded by the specification. Independent labs or quality testing centers should be set up in each region to certify the quality, grade, and quantity of commodities so that they are appropriately standardized and there are no shocks waiting for the ultimate buyer who takes the physical delivery. A committee can be created where personnel from the Department of Agriculture, Jute Export Corporation, and agricultural research institutions will work to support quality testing institutes.?

12.3??Development of Co-operative Society among Participants of the Exchange Market

To ensure the involvement of the farmers in the commodity exchange system, Samity/Co-operatives can be built among them. Collaboration with Community Information Centers/ Support from the ICT sector can be taken. Other participants (from non-agricultural products) can build their separate associations based on their sector and this will help them to obtain regular information.?Involvement of Financial Institutions and Argo-processing Industry Involvement of financial institutions will play a very important role in the development of the commodity exchange market. They can assist participants in the commodity exchange market by accepting warehouse receipts as collateral. Financial institutions also have to play a positive role in the clearing and settlement of the exchange market.?

12.4??Development of Market Information System

The commodity exchange market will require a proper information system for ensuring market information available to all. The commodity exchange market needs a "Gateway" between the traders and the commodity exchange, which will manage all the transactions and database operations between the traders.

12.5??Awareness Building

From the perception survey, it was found that a lack of awareness or knowledge ‘of the system among various market participants caused several commodity exchanges to become unsuccessful. So, a massive awareness campaign should be developed before the implementation and at the initial stages of the exchanges.

12.6??Fund Source Determination

The estimated total resource requirement for the establishment of commodity exchange is around USD 18 million. This is an estimation of the experts employed by the MOC. Almost 80% of the total resources would be allocated for automation and computerization. Besides, a lot of funds will be needed to meet the other prerequisites. The source of financing has to be determined.

13???Conclusion

The establishment of a commodity exchange market in Bangladesh will open up a new door of opportunity for farmers/producers. Through this exchange market, they will be able to reduce financial loss which they face every year due to a mismatch between supply and demand during peak season. The commodity exchange market will provide advance price signals to sellers (farmers/producers) and will assist buyers (consumers) of agricultural commodities for financing commodities from one season to another. The opportunity for future selling will also encourage them to deliver quality commodities to the buyers. By analyzing the performance of the commodity exchange market of our neighboring countries like India, Nepal, and Pakistan it has been found that they are positively contributing to the economy. Lack of infrastructure facilities, poor awareness among stakeholders, and weakness of regulations are the main reasons for not attaining the expected benefits from some exchanges.?From the study, it is found that, despite multiple challenges and drawbacks commodity exchange markets would be quite successful in making significant positive contributions to the economy. Even in countries where the commodity exchange markets were not so successful, the underlying reasons are not beyond control. The commodity exchange market has not been fully initiated in Bangladesh yet though Bangladesh has the expert resource/s who worked in the establishment of the commodity exchange market in Myanmar and experienced operations of our neighboring countries like India. So the successful implementation of such markets is quite possible here which will benefit a large group of participants.