www.ifc.org/ThoughtLeadership Note 37 | April 2017 Creating Agricultural Markets: How the Ethiopia Commodity Exchange Connects Farmers and Buyers through Partnership and Technology Commodity exchanges can provide emerging market economies with orderly, transparent, and efficient markets by acting as mechanisms that mitigate price risk, discover equilibrium prices, and connect buyers and sellers. Exchanges can also reduce transaction costs and information asymmetries by using technology to disseminate market information while creating better supply chains. The Ethiopia Commodity Exchange is striving to transform Ethiopia’s agriculture sector from a fragmented one marked by high transaction costs and low quality standards to a thriving and reliable part of the country’s economy. Ethiopia’s exchange continues to expand its activity across the farming regions of the country. Commodity trading has existed for hundreds of years. The first "If properly organized, a whole array of other problems, commodity exchanges were in Asia where Japan established an including problems with finding buyers or sellers, quality exchange for rice in Osaka in the 17th century and traded with problems, difficulties in obtaining credit, and counterparty futures contracts as early as 1697, almost two centuries before risks" can be solved through exchanges.2 they were used in the United States in 1867.1 Ethiopia now joins These exchanges further support the warehousing, the ranks of these nations with its Addis Ababa-based Ethiopia transportation, quality accreditation, financial services, and Commodity Exchange, or ECX, launched in 2008 with the goal telecom and insurance sectors, allowing them to flourish. of transforming the country’s agricultural sector. The purpose of commodity exchanges Figure 1. Benefits of commodity exchanges to emerging Commodity exchanges are organized market venues where markets Venue buyers and sellers of a commodity meet to trade it or its for investment derivatives. They are designed to help mitigate counterparty H Price risk risk and ensure that payments are made through reliable management financial service providers. Exchanges provide a framework for Market market actors, financial institutions, and commodity operators Market growth development to interact based on rules that provide legal protections. Channeling finance Exchanges further reduce information asymmetry. This to agro sector encourages competition among buyers and sellers by allowing Facilitate physical them to discover the real value of commodities in the market. commodity trade Commodity exchanges in emerging markets typically trade Market with spot contracts that offer immediate delivery of the traded transparency good, while those in more advanced economies tend to trade in L Price discovery futures and options contracts. Commodity exchanges are adaptable and can remedy several High Priority Low risk factors in emerging markets, including price risks, poor Source: Based on UNCTAD Report, Development Impact of price discovery, and a lack of market transparency (Figure 1). Commodity Exchanges in EM, 2009 The Ethiopia commodity exchange market half of 2017 alone. Other traded commodities include green Ethiopia’s exchange was formed to overhaul the country’s mung beans, red kidney beans, wheat, and maize. agriculture sector and create a dynamic, forward-looking, and efficient agricultural market system. 3 The first modern Figure 3. Transaction value for coffee and sesame commodity exchange in Sub-Saharan Africa outside South T RADE VAL UE IN MIL L I O N Africa and a pioneer for Rwanda’s East Africa Exchange, it US D now connects 3.5 million Ethiopian smallholder farmers to markets.4 Coffee Sesame White Pea Beans Similar to those in most emerging markets, Ethiopia’s exchange 825 901 was launched with an open outcry system which deployed spot 1,000 558 664 720 724 665 contracts for three staple foods—maize, wheat, and haricot beans—with one satellite delivery center and two partner 500 293 268 394 590 commercial banks. 2 1 21 31 61 - 14 Before its launch, Ethiopia’s agriculture sector was fragmented and suffered from high transaction costs, equally high contract default rates, a lack of quality standards, and an unreliable commodity supply. Source: Ethiopia Commodity Exchange Strategy Planning Unit Weak infrastructure in terms of electricity, roads, Report, 2016. telecommunications, financial services, and warehouses, along with an absence of necessary market infrastructures, including reliable and timely market information, standards, and reliable Ethiopia’s exchange was positioned to function as an end -to- ways to connect buyers and sellers, all hampered the end service for commodity warehousing, quality control, exchange’s initial progress.5 trading, clearing, and market data dissemination. Its indigenous all-in-one model gave it the functions of an exchange, quality In the eight years since its inception, the exchange has evolved certifier, warehouse operator, and clearinghouse. to handle larger trade volumes (Figure 2). The volume of coffee However, in order to advance the service provision, this model and sesame traded has grown from 138,000 metric tons in 2008- was replaced in 2016 by a system placing the warehouse and 2009 to 715,000 metric tons in 2015-2016. quality control operations and the central depository functions Figure 2. Volume of traded coffee and sesame under the Ethiopian Agricultural Commodities Warehousing T RADE VO L UME IN Service Enterprise, a separate business entity. A regulatory body, the Ethiopian Commodity Exchange Authority, was also ME T RI C TO NS (000) established to oversee the overall operation of the exchange as well as its external operators. Coffee Sesame White Pea Beans A lack of awareness about structured markets was a daunting 500 hurdle in the initial stage of the exchange’s implementation. 421 The exchange has successfully marketed itself through 400 303 intensive campaigns and the training of farmers. 299 300 238 237 The partnership 200 138 Ethiopia’s exchange is a commercial non-profit entity 234 222 240 257 225 established as a public-private partnership. Unprecedentedly, it 100 0.1 0.4 is jointly governed by private and public sector members of its 82 Board of Directors, with five of the eleven board members from 0 41 67 37 the private sector.6 Major decisions such as adjusting fees, reinvesting net profits, appointing chief executive officers, and approving and amending exchange rules require a two-thirds majority vote. Source: Ethiopia Commodity Exchange Strategy Planning Unit The exchange is demutualized, however, with ownership Report, 2016. (represented by the public sector) separated from membership and management. Memberships are classed into ordinary As depicted in Figure 3, Ethiopia’s commodity exchange trade (trading and intermediary) membership, which entitles the value of coffee and sesame have remained buoyant—about 10 member to a permanent seat on the exchange, and special billion Ethiopian birr (equivalent to $440 million) in the first (limited trading and intermediary) membership, which is valid 2 for a year. Permanent membership seats are sold at auction and functions, and the ability to cater to far more participants.11 The cost $75,000 per seat on average,7 giving the member the right majority of the exchange’s trades are now made electronic ally. to trade commodities on the exchange. Ethiopia’s exchange is also expanding its activities throughout In total, Ethiopia’s exchange has 346 members, including 3 3 the country’s major agriculture producing areas. The goal is to farm cooperatives, of which 7 percent are trading members.8 open more trading centers in order to increase liquidity and Ordinary members have the right to govern the exchange by accessibility to both commercial and smallholder farmers. The being elected as a representative to the Board of Directors. exchange’s second trading center, built in Hawassa, will begin operations by the end of 2017. Members are expected to produce an audited financial statement that satisfies the minimum net worth requirement according to their membership class. To actively trade in the exchange, members (either a person or a business) must secure recognition as ‘exchange actors’ from the Ethiopian Commodity Exchange Authority. A technology-driven exchange Ethiopia’s technologically advanced exchange offers trades based on an electronic warehouse receipt system that links data from warehouse operations, clearing and settlement, and market-information onto one platform. The system also has a warehouse receipt financing component to provide short-term working capital loans to small-scale traders. The exchange also provides a fully secured clearing and Ethiopia Commodity Exchange (ECX) Addis Ababa, Ethiopia settlement service and central depository that are electronically linked to eleven commercial banks and a warehouse operator, Integrating traceability into the exchange which in turn is linked to a network of warehouses across the Since its launch, Ethiopia’s exchange has traded more than 3.9 country. million metric tons of agricultural commodities. However, only a fraction of these commodities were traced to their source These connected warehouses reduce price dispersion among using a traceability system. regions and transaction costs for regional farmers. 9 The Food regulations in Europe and the United States require exchange’s secured payment system is digitally linked to the traceability of commodities along the agricultural value chain, warehouse operator, financial institutions, tax administration as part of international requirements to meet health and safety agency, and more than 16,000 traders. standards. The European Union General Food Law, for example, mandates that all food and feed producers and The exchange settles transactions of more than $10 million per operators have a traceability system. 12 day with settlements made the following business day. Similarly, the exchange’s clearinghouse has cleared more than Growing concern about a lack of traceability, particularly for $6 billion worth of transactions so far without default. coffee, prompted Ethiopia’s exchange to initiate a traceability project on export-oriented commodities, including coffee and Market participants in Ethiopia now have access to reliable sesame, in 2013. market data through various sources provided by the exchange, Two years later the exchange officially launched its cloud- including a mobile push service that delivers up-to-date daily based IBM-enabled national traceability system, which runs market information to farmers and agro-processors via text jointly with the warehouse operator Ethiopian Agricultural message and interactive voice response services offered in Commodities Warehousing Service Enterprise. The $4.5 Amharic, Oromoiffa, Tigrigna, and English. million program, implemented in collaboration with the United As a result, small-scale farmers receive 70 percent of the final States Agency for International Development, was designed to price of a trade, up from 38 percent prior to the establishment function with a bar code system to track commodity trades.13 of the exchange.10 The agriculture sector is now required to disclose data on quality, health and safety standards, as well as the movement of The exchange continues to innovate. In July 2015, with the help commodities along the supply chain, from the processing unit of a $2.2 million grant from the Investment Climate Facility for to the shelf. Businesses associated with the agriculture sector, Africa, it introduced a $3.8 million electronic trading platform including commodity suppliers and warehouse operators, to replace the original open outcry system. This created the greatly benefit from the tracking, which helps detect capacity to execute significantly more transactions than the embezzlement and fraud as well as poor quality products, and former system, with greater speed and data capture display also helps warehouse operators optimize storage space. 3 The traceability process (Figure 4): Bags of commodities traded conditions.14 Bags containing close to 27,000 metric tons of on the exchange are tagged with geo-referencing to washing coffee have been tagged and traded by the exchange so far.15 and hulling stations or aggregation points throughout Ethiopia’s Still at the pilot stage with only two locations, Ethiopia’s agricultural regions. The bag-tagging system provides the traceability project—designed to satisfy trading partners’ rules- commodity exchange with continuous real-time data analytics. of-origin requirements—is expected to become a full-scale It is also capable of learning and predicting the quality of operation for both coffee and sesame commodities within the commodities based on domestic growth and processing next few years. 16 Figure 4. Traceability process flow Source: Traceability project 2014; EACWSE = Ethiopian Agricultural Commodities Warehousing Service Enterprise. Conclusion An efficient and reliable commodities exchange system can Abenet Bekele Haile, Chief Strategy Officer, Ethiopia provide producers and agribusinesses in emerging markets with Commodity Exchange, Addis Ababa, Ethiopia, and currently a competitive edge. Research Assistant at Thought Leadership, Economics and Private Sector Development, IFC via the Milken Institute The implementation of information technology in exchanges Capital Markets Program (ahaile@ifc.org) can have a transformational effect for emerging markets, delivering transparency, access to market data, and the ability Ariane Volk, Research Assistant, Thought Leadership, Econo- to trace and determine the quality of products. It plays a crucial mics and Private Sector Development, IFC (avolk@ifc.org) role in creating and promoting fair and orderly markets and mitigating price risks. Thomas Rehermann, Senior Economist, Thought Leadership, Exchanges can also bring broad-based economic benefits, Economics and Private Sector Development, IFC stimulating growth while linking smallholder farmers, financial (trehermann@ifc.org) institutions, and communications technology. 1 Bakken, Henry, Futures Trading – Origin, Development and Present Development, Discussion Paper Series 16-02, January 2016, 16-02. Mihretu, Economic Status, 1966. M Warehouse Financing: Lessons from Ethiopia, IFC, 2012. 2 UNCTAD Report, Emerging Commodity Exchanges: from Potential to 10 Gebre-Medhin, Eleni Z, A Market for Abdu: Creating a Commodity Success, UNCTAD,1997. UNCTAD Report, Development Impacts of exchange in Ethiopia, IFPRI, 2012. Commodity Exchanges in Emerging Markets, UNCTAD, 2009. 11 See ECX to Launch online trading Operations, ICF, December12, 2013, 3 Gebre-Medhin, Eleni Z, The Devil is in the Details - Understanding a available at http://www.icfafrica.org/news/ecx-to-launch-online-trade- Commodity Exchange, The Fortune Newspaper, December 2006. operations 4 ECX Report, Annual Report 2015/16, ECX Strategy Planning Unit, Addis 12 See Traceability, Wikipedia.com, Accessed on January 24, 2017, at Ababa,2016. https://en.wikipedia.org/wiki/Traceability 5 Gebre-Medhin, Eleni Z, A Market for Abdu: Creating a Commodity 13 David Kahrmann, ECX Launches independent food Traceability System, exchange in Ethiopia, IFPRI, 2012. USAID,2012, Available at https://www.usaid.gov/ethiopia/press-releases/ecx- 6 Ethiopia Commodity Exchange(ECX), The Rule of the Exchange launches-independent-food-traceability-system 14 Commodity Exchange, Rev No.5/2010, ECX, July 2010. House of People Ibid. 15 Representative (HPR), A proclamation to provide for the establishment of ECX Report, Annual Report 2015/16, ECX Strategy Planning Unit, Addis Ethiopia Commodity Exchange, Proclamation No. 550/2007 Federal Negarit Ababa, 2016. Gazita Addis Ababa, September 4, 2007. 16 Bekele, Abenet, ECX’s Coffee Market: Traceability and New Developments, 7 ECX Report, Assessment on ECX Membership Transfer, ECX Member 14th AFCA Conference & Exhibition. Dar es Salaam, February, 2016. Development Unit, Addis Ababa, 2016. https://afca.coffee/conference/wp- 8 Ibid. content/uploads/presentations/14AFCCE/Abenet%20Bekele%20- 9 Andersson, Camilla, Bezabih, Mintewab, Mannberg, Andrea, The Ethiopian %20Ethiopian%20Commodity%20Exchange%2C%20Traceability%20and%2 Commodity Exchange and Spatial Price Dispersion, Environment for 0New%20Developments.pdf 4