Time to establish a commodity exchange

Prices are determined by the market forces-demand and supply. It is said in jest that a parrot can be turned into an economist by teaching it just two words-demand and supply. This saying contains a great deal of truth. If we want to control the price, we have to manipulate either the demand or the supply or both. And among other types of manipulations, the worst type is blocking the information flow or concealing them. Free market economy's success mostly depends on free flow of information, which the government should ensure. That will stop manipulation.
Commodity markets in Bangladesh have a two-pronged problem. On the one hand the consumers are in trouble with the increased price level, but on the other the growers are getting prices below the production costs at times. So a commodity exchange is needed for putting in place a permanent regulatory regime.
A REGULATED COMMODITY EXCHANGE: When we talk about an exchange for commodity, we need to take a look at the existing stock exchanges. No doubt, the stock market in Bangladesh is witnessing a turnaround.
When it comes to the discussion of commodity prices, it is very much relevant to refer to the growth of the stock market. This will be within the periphery of the regulated securities market. A regulated commodity exchange in the basic form and nature will very much resemble a stock exchange. However, the scope of a commodity exchange is much wider than any of the stock exchanges that we have now. Commodity exchanges are said to be a complete ecosystem. It is not only a trading floor or a trading system on the computers.
CHALLENGES OF ESTABLISHING A COMMODITY EXCHANGE: A successful commodity exchange will adopt the definition of hoarding, storage and warehousing. It will very clearly define the standard of each and every commodity.
In Bangladesh, we have seen how wide-ranging the problem of adulteration can be. We have seen mixture of low-quality and cheap things in branded items, use of poisonous chemicals for preservation in fish and fruits, even naming of fully vegetable oil as cow milk. A commodity exchange for a spot market will need a set of state-of-the-art laboratories throughout the country which will guarantee the quality of commodities. The assurance about quality can bring in a series of positive impacts-on the public health, standard of living and image of the whole country that we care for quality. It will be an impressive image contrary to what we have now.
A commodity exchange will essentially need a computerised system with a nationwide network (with international access) so that indigenous producers, traders, international market players as well as local consumers can know the price of the commodity of their choice all the time. It will provide the government with an effective tool to know the price trend and plan any intervention as and when required. A commodity exchange can ensure the flow of information, a necessary condition for success of the market economy.
DERIVATIVES FIRST-SPOT LATER: A commodity exchange, as an ecosystem, is a big and wide operation. It is, therefore, not possible to buy a computer system and establish a commodity exchange overnight. This vast ecosystem has to be implemented bit by bit based on a well-designed master plan.
All the countries that this scribe knows started their regulated commodity markets with derivatives. Derivatives are a very sophisticated financial mechanism. But in fact, it is much less complex a system than a regulated spot or cash market. For example, in India, they have a derivative regulatory commission, the Forward Market Commission (FMC) established in 1954. India began a regulated spot market later when acceptable standards of warehousing, product quality control and transportation systems were created. For example, growers of mangoes in South India have computer terminals in their orchards. For the small growers, cooperatives are the most useful channels. On the computer terminal, they can see the prices being offered for mangoes of different qualities. They thus have a price discovery mechanism. The National Spot Exchange, which is providing this robust computer system, also takes the responsibility of delivering the right quality and right quantity of produce in time for the buyers and, for the sellers, the payment at the right time. Benefits of this system include transparency of pricing. And the government monitors the trend of prices.
A laptop computer, powered by a car battery and operated by a barefooted man in a remote mango orchard in our Rajshahi district may be unthinkable for many now. But we can develop a plan and it is doable certainly. However, we are not yet ready with any appropriate Warehousing Act or Consumer Product Quality Act, etc.
A Mercantile Exchange can launch Commodity Derivatives, as the Securities and Exchange Ordinance allows the Bangladesh Securities and Exchange Commission (BSEC) to regulate the investment contract and forward markets. A private sector exchange can begin the operation within the BSEC-framed regulations. Baton wielding will also be required. But that will be effective and sustainable, when we can define the crimes and identify the real criminals as per the definitions in the law.
After we have the derivatives market in place, gradually, say within two to three years, a spot market can be started ensuring fair prices of quality commodities for growers and for the consumers alike. And this is the right time to begin an executable plan.
DERIVATIVES FACILITATE HEDGING RISKS: A derivatives market is not only a preparation for a spot market. A derivatives market, which is a futures market, has its own beauty. It allows producers to hedge risks. A derivatives market recognises the reality of presence of speculators and their very positive roles. Speculation is a basic instinct of a human being. In the market the speculators' presence is inevitable and indispensable too. This fact is recognised in all the market economies that are holding trading in derivatives. Speculators are counterparts of the hedgers. They absorb and distribute the risks through a sophisticated financial mechanism. A producer, who expects a good return for his commodities, say Tk 300 after three months, may have the fear also that the price on that future date may go down causing losses. If there is a derivatives market, he can sell his produce right now for delivery or cash settlement on that future date. Speculators, who are able and willing to take risks, will buy commodities or investment contracts giving the producers an opportunity to lock the price (hence profit) of their produce. Surely, a derivatives market is a wonderfully proven mechanism to effectively hedge the price risks for the producers, especially the agro-commodity producers.
And for the consumers, traders and regulator, this futures market gives a signal for the future price trend. When the price trend is adverse due to any supply-demand mismatch, it is possible to take adequate measures in time.
We have to remember that the derivatives market itself cannot stop price fluctuations. It is like a barometer for the market; a barometer cannot influence weather. It gives a signal so that precautions can be taken. Without a derivatives market for commodities, we are lacking a barometer about the storm scare.
HOW CAN WE PROCEED: First, we need a regulatory framework. The need for 'baton wielding" will never cease, as this is impractical and foolish to expect a society with zero crime. However, it is imperative that we have a very clear and transparent definition of crime and ways to catch the criminals. We will catch the criminals immediately and punish them in order to protect the law-respecting folks. A patriot and welfare-cautious government can examine the scopes given in the existing laws. As laws are always subject to continuous revision, as society and the economy change, we may need some addition to the existing laws. And then a private sector body can come up for mobilising resources to establish a sustainable organisation to operate as a mercantile exchange.
Partnership with a foreign commodity exchange will be highly desirable as the critical factors for success will depend on technology and the pool of knowledge. Instead of attempting to reinvent a wheel, we can take the technology and knowledge from another commodity exchange.
The writer is chairman and managing director of Alliance Capital Asset Management Limited. [email protected]