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Planning for the Perfect Storm: Regulation of Commodities Trading in Agricultural Products

23.05.2011Matt Troniak

Today, as fuel prices go up, and food prices increase, we are all well aware of the risk of social unrest and civil strife. The world needs affordable food, for a growing population, in a natural environment that is increasingly volatile due to climate change. Whether we can meet these needs will depend upon how we evaluate and address the agricultural investment risks and returns and how we regulate investment in agriculture.

Investors are well aware of this opportunity. Blackrock Global Funds in marketing its World Agricultural Fund comments: "The agriculture sector has, to an extent, lagged other parts of the commodity markets. However, the demand fundamentals continue to improve and with inventories in some agricultural commodities at historically low levels, we believe agriculture is a compelling long-term investment. We have identified three powerful drivers of agricultural commodity demand. These are; rising population, rising incomes and the growth of biofuels.With inventories in some agricultural commodities at low levels, these demand drivers are likely to put upward pressure on prices."

In addition to the traditional risks in agriculture we now have a large and growing man made risk. This is the risk that results from the "financialization" of food commodities. The free market system combined with international trade and international finance enables wondrous technology and a standard of living beyond compare in some parts of the world enabled by investments attracted by the risk reward trade off. But the dark side of these free markets could be viewed to be financial speculation on food facilitated by un-regulated or loosely regulated markets.

An interesting question that is facing us is whether it is morally and ethically correct to "speculate" on food? Is it correct to allow un-controlled and un-regulated profit seeking to withhold grain supplies in a period of shortage? Is the way we account for profits in the scenario correct when we do not charge the private sectors profit and loss statement with the costs of social unrest, riots, wars and the like? Should we do anything to ensure this profit seeking is moderated and regulated? Do we truly believe that "Greed is Good?", as the character Gordon Geko in the movie Wall Street said. Have we not just seen and experienced the result of poor regulation and oversight on the world economy. Can we afford to take this risk with our food?

Fortunately there are already calls for regulation of financial speculation in commodities and thus food commodities. But the requisite legislation and regulation is far from implementation. There is "a pressing need for new measures of transparency and regulation to deal with speculation on agricultural commodity futures markets," said Jacques Diouf, Director-General of FAO.

In the report World Economic Situation and Prospects 2011 published by the UN it is noted as follows: "The traditional function of the commodity exchanges has been to facilitate price discovery and allow for the transfer of price risk from producers and consumers to other agents that are prepared to assume such risk. But these functions have become impaired by the growing “financialization of commodity trading."

In the article "How Institutional Investors Are Driving Up Food And Energy Prices" by Michael W. Masters and Adam K. White, CFA ed. Institute for Agriculture and Trade Policy, the authors note that: "When Physical Hedgers dominate the commodities futures marketplace, prices accurately reflect the supply and demand realities that physical consumers and producers are experiencing in their businesses. When Speculators become the dominant force, prices can become un-tethered from supply and demand, reaching irrationally exuberant heights."

Federal Reserve Bank of St. Louis in an article “What Explains the Growth in Commodity Derivatives? By Parantap Basu and William T. Gavin, ed. Institute for Agriculture and Trade Policy, documents: "During the past decade, many institutional portfolio managers added commodity derivatives as an asset class to their portfolios. This addition was part of a larger shift in portfolio strategy away from traditional equity investment and toward derivatives based on assets such as real estate and commodities. This trading was directly related to the search for higher yields in a low interest rate environment. The growth was both in organized exchanges and over-the counter (OTC) trading, but the gross market value of OTC trading was an order of magnitude greater. This growth is important to note because a critical factor in the recent crisis was counterparty failure in OT C trading of mortgage derivatives."

In this regard we need to consider the issue of investment in agriculture in our deliberations on Making Finance Work for Africa. We should seek to assist governments, producers, and consumers to regulate their Commodities Exchanges and Over the Counter Markets to ensure that they function to enable price discovery, facilitate agricultural trade and financial hedging, and to ensure that "speculation" is driven out of the food commodities market. If we do not do this - we increase the financial, social, political, and economic risks in fragile states and emerging nations alike and we do so at our peril.

The author has worked in the areas of agriculture investment and development including value chain financing for over ten years in Africa and Asia. He is currently involved in researching and implementing, as well as training on, risk mitigation tools to enhance the flow of funding to agriculture production and processing with a focus on Small and Medium Enterprises in agricultural value chains in emerging markets.

Developing an e-payment system in Africa: Issues and Challenges

08.05.2011Blaise Ahouantchede

I. Low banking services in Africa: a constraint on financial services development

The banking rate in Africa is still low, making it hard to overcome the challenge of developing financial services necessary to strengthen African economies. In the eight West African Economic and Monetary Union (WAEMU) states which have eighty-four million people and some one hundred banks, this rate - which is less than 10% - does not allow for the establishment of a solid and sustainable development strategy for a mass financial system.
Several initiatives are however underway to reverse this trend. These include adapting regulations, sensitizing various actors, educating the population on the financial culture, providing adapted and accessible services at reduced costs, and ensuring the security of financial transactions to instill confidence in clients.

II. The role of actors and strategy type

Central banks have an important role to play in improving the banking and financial landscape by adopting proper regulations designed to foster the development of banking and financial activities in Africa. As a result, in the WAEMU zone, the Central Bank of West African States (BCEAO), through Order No. 08/2002/CM/UEMOA, promotes access to banking services and the use of electronic payment systems. Following this directive, WAEMU member states were  also expected to adopt similar laws in line with the directive.
These measures are necessary to sensitize various segments of the society on the use of encrypted means of payment, including e-payment which is playing a prominent role.
GIM-UEMOA”, the e-payment governance and supervisory body within WAEMU, has established an interbank e-payment system in the region by providing world-class technical and operational infrastructure, making it possible to meet cash withdrawal and payment needs through bank cards.
Strategic partnerships have also been established with international issuers to enable GIM-UEMOA member banks to offer valuable services both within and outside the WAEMU zone while respecting BCEAO regulations for operations conducted within WAEMU, in particular, balancing and settling electronic financial transactions conducted in local currency. The establishment of a unified zone regarding the processing and management of interbank operations, a sign of real financial integration, is therefore one of the major achievements in the WAEMU zone.
Banks also promote the development of financial services through an innovative and differentiated approach based on their marketing and sales strategies.

III. E-payment’s contribution to the expansion of banking services and the promotion of financial inclusion

Electronic banking is and will remain an essential element in efforts to expand banking services to the population given that it targets people with or without payment means. The major challenge facing banks is therefore to establish and provide competitive electronic payment systems to the continent’s increasingly demanding population. This will imply controlling investments and operation costs which are relatively high.
The creation of the “GIM-UEMOA” in the WAEMU zone therefore meets a key objective of pooling investments by adopting a sub-regional interoperability strategy for e-payment operations enabling banks to provide local services at reduced costs.
The establishment of these regional champions such as the GIM-UEMOA in West Africa, OMAC in Central Africa, and a soon to be active inter-banking system for ECOWAS, and the need for an interconnection of these systems, should one day enable Africans with payment instruments such as credit cards or other electronic payment facilities to easily conduct financial transactions anywhere in Africa, without thinking about foreign exchange issues.
Africa will therefore become a unified zone, facilitating trade and strongly fostering financial and economic integration.

IV. Future challenges

New Information and Communications Technologies are enabling major players such as banks to provide high value-adding banking and financial services to their clients, based on payment methods such as bank cards, the Internet and mobile phones.
With a fairly high penetration rate of about 50% in Africa, mobile phones will, within the next years, undoubtedly become a payment method that will revolutionize the continent’s financial and banking landscape. The bank will be electronically connected and it will be close to its clients. This will also enable banks to innovate and earn new commissions from financial services, thereby increasing their net banking revenue. This is a great challenge for all stakeholders such as central banks, regional champions such as GIM-UEMOA, Banks, financial institutions, microfinance institutions, etc.
 

Blaise Ahouantchede, GIM-UEMOA’s Director General since 2003, has more than fifteen years of experience in finance, banking and project management. A polytechnic engineer and a holder of an MBA from Paris Dauphine, he also has two graduate degrees in information systems and in business and project management from Paris XII, France.
Before becoming the director-general  of GIM-UEMOA, he was, for more than eight years, a banking and finance project manager with ‘Crédit Agricole du Sud et au Crédit Agricole Indosuez’ in France, where he was in-charge of retail services and back-office operations, financial products research, as well as mergers and acquisitions operations.  He was also project director at the deposits and consignment office in France responsible for bank projects and payment methods.

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