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On the saddle: Commodity exchanges

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As Malawi will for a long time continue to be an agricultural-based economy, with 80 percent of the population being in the rural areas, it is evident that improving the livelihoods of Malawian farmers should be of paramount concern for the country to achieve meaningful economic growth and development.

Malawi’s farmers predominantly are largely subsistent and sell their surplus to generate cash to meet other needs.

One of the major set-backs for smallholder farmers has been access to markets and the ability to realise prices commensurate with their expectations in view of their inputs.

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Middle-men have taken advantage of the lack of a proper formal grain purchasing mechanism by offering low prices at harvest time to desperate farmers, who often find that they do not have the resources or facilities to effectively store their produce.

The idea of a commodity exchange i s to create an organized marketplace in which order and integrity prevail, which serves all market players equally, and where transactions are conducted in as efficient and low-cost manner as possible.

An effective marketing system along these lines should help Malawi to transform its agrarian economy from a largely subsistence oriented, low-productivity base, to one that is modernized and market-oriented.

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A primary function of a commodity exchange is coordinating buyers and sellers.

The exchange also creates market transparency by providing information on product grades, on prices, and on offers and bids for given products.

This signals opportunities for profitable trade; it levels the playing field between farmers and others with better information; and it opens up new markets within and outside of the country.

Another central function of the exchange is to provide security to transactions, making it less risky to trade across long distances, across time, and with unknown counterparties.

A commodity exchange is defined as an institution that determines and enforces rules and procedures for the trading of commodities and related investment, such as commodity futures.

It operates in a structured and organized market platform that is accessible by all stakeholders and facilitates trading in agricultural commodities for both local and foreign participants.

The pricing of commodities traded is transparent and efficient as the exchange is not involved in price setting. Its role is trade facilitation while the seller offers the commodities at an open and competitive price, determined by the prevailing economic circumstances as well as their profit margin.

The buyers on the other hand place buy orders at prices that are commensurate with prevailing economic conditions and their cost structure and competitiveness is attained due to the multiple buyers – both local and foreign, interacting with multiple sellers on a particular trade day.

Thus, trading is executed on the ‘Willing Buyer-Willing Seller’ principle and on terms as agreed between the buyer and the seller, through an open, transparent, competitive and fair transaction interface.

Establishment of commodity exchanges means that Malawi has embarked on a great collective learning exercise in what is bound to be a fundamental agrarian transformation that will have a far-reaching, positive impact on our economy.

On the exchange, all orders to buy and sell are made by members who either trade for themselves or on behalf of others.

Members may be brokers or processors or even cooperatives and other institutions accepted as such by the exchange.

Because members a r e liable for their transactions, membership is limited and is on the basis of very clear and transparent criteria, including trustworthiness, performance, capital adequacy, and willingness and continuous ability to follow the exchange rules.

To trade on the exchange, the owner of a physical product must bring the product to a certified warehouse, where it is sampled, graded, weighed, and issued a certificate or warehouse receipt.

That certificate represents the identity of the commodity, and is the basis for a transaction on the exchange. A warehouse receipt is thus effectively legal title to the product and can be used to access finance from a bank based on the underlying physical commodities as collateral.

In this way, the role of the warehouse is similar to that of a bank, crediting and debiting deposits of an asset which, in this case, is a commodity asset, rather than money.

Once the warehouse receipt is issued, the seller can proceed to make an offer to sell a certain number of contracts at a standard lot size and grade on the exchange.

Because contract terms are standard, the key parameters are the price, delivery time, and location. On the other side of the transaction, a buyer similarly places a bid order through a broker and is required to place funds into a settlement account before submitting a buy order.

Once the deal is made, the process of clearing and settlement of the contract begins to ensure delivery of the product and the transfer of funds.

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