One of the recommendations of the Nigerian Capital Market Master Plan 2015 – 2025 is the development of a thriving commodities trading ecosystem. This is necessary to deepen the capital market, increase the number of product offering, enhance agricultural and solid mineral production and spur economic development. As part of the implementation strategy therefore, the Securities and Exchange Commission (SEC) constituted a Technical Committee (TC) in June 2017 on the Commodities Trading Ecosystem in Nigeria with the following terms of reference:
- Undertake assessment of existing framework/infrastructure to identify challenges and gaps;
- Develop roadmap for the enhancement of the Commodities Trading Ecosystem; and
- Undertake any other activity that may be relevant to the achievement of this mandate
COMMODITY TRADING AND ITS IMPORTANCE
Commodity trading ecosystem can be defined as the environment within which commodities trading takes place and directly or indirectly, affects activities and development of the commodities market and the exchanges. The ecosystem is comprised of various elements, which are integral to the architecture of the market and vital to the smooth and efficient functioning of a commodity market or exchange. The ecosystem encompasses all spheres of the commodity trading environment such as its operations, products traded, infrastructure, logistics, traders/brokers, commodity merchants, farmers, miners, end users and other stakeholders. It also covers the legal and regulatory environment. If these elements are absent, inefficient or underdeveloped, the commodities trading ecosystem would not be well functioning and so maximum value may not be derived from its existence.
A commodities market is simply a market, a medium for connecting buyers and sellers of commodities. It may be formal (organised) or informal (unorganised), have physical location with central trading places or virtual without a specific trading location, in which case trading can be conducted remotely by participants. Our focus is however, primarily on promoting the formal or organized market such as commodity exchanges, which provide a formal and more structured mechanism for trading in designated commodities.
We believe that such markets provide significant value addition to economies; a reason why countries make concerted efforts to develop them. This view is buttressed by Chuck Kowalski who observed that “it’s unlikely that the US would have experienced as much economic growth in the last 100 years as it has without them (commodity exchanges).’’ This observation by Chuck Kowalski is perhaps also true of many other countries. This importance has seen commodity exchanges sprang up all over the world, in developed and developing countries, trading all kinds of commodities from agriculture, to metals and precious stones.
While commodities exchanges have existed for more than a century in some developed countries, they are a more recent phenomenon in developing countries. In Africa, most exchanges, with the exception of the defunct Egyptian Commodities Exchange, which was established in the 19th Century, are relatively very recent initiatives.
A commodity exchange is a market, which provides facilities (platform), regulations and standards for the orderly, efficient and transparent trading of designated (selected) commodities. Contracts are created with standardized features, which thereafter become tradable financial instruments. The commodities traded may or may not be for delivery and indeed in many exchanges, most trades are not for physical delivery. Commodity exchanges tend to gravitate from spot market to forward to the more complex derivatives market.
Benefits of Commodity Exchanges
There are several reasons why commodity exchanges are important to the economy. Many of these reasons have been well documented, some of which are listed below:
- They promote economic growth by fostering the development of both soft and hard commodities by efficiently linking commodities to industry, which could improve industrial output and profitability. A thriving commodity trading ecosystem, can therefore, facilitate industrialization of the economy and improve tax revenue;
- They create employment and raise the living standard of the farming community as opportunities are provided for better access to market, produce marketing, access to market price and other important information, which could lead to improved produce prices for farmers, among other benefits. Since small holder farmers are usually the rural poor, improvement in their living standards can have positive impact on rural development and mitigate rural – urban migration;
- They can serve as a platform for small holder farmers to be brought into the financial sector as they get exposed to financial services such as bank deposit and credit facilities, thereby fostering the much needed financial inclusion;
- They engender economic diversification. This is more so for an economy like Nigeria, which is heavily dependent on a single product for its foreign exchange earnings, namely crude oil. For an essentially agrarian economy like ours, with good solid mineral deposits, developing the commodities market remains a potent way to diversify the economy away from crude oil, as well as widen the national tax base. A diversified economy will potentially diversify the export base and improve government revenue;
- They improve the attractiveness of agribusiness and foster agricultural production as farmers and end users benefit from the use of the exchange. As value is seen and derived from the exchange, more people are likely to be drawn to agribusiness. Increased production would reduce import dependence and encourage more private investment in the agricultural sector;
- As a platform and transparent pricing mechanism is provided for trading solid minerals, activities in this sector could go up and more investment attracted with multiplier effect on the economy;
- Through the provision of price and other information transparency as well as better access to market, they reduce the exploitation of smallholder farmers by intermediaries. This enhances value to farmers, improves their well-being and encourages farming activities;
- They provide rules and regulations, which bring order to the market. This in turn forces and encourages producers, including farmers, and traders to meet the ethical and quality standards of the market;
- By efficiently linking buyers and sellers in sufficient number, commodity exchanges create liquidity and facilitate price discovery, which further bolsters commodity trading. Market information such as price, quantity and quality are regularly made available to the public which aids decisions and trades;
- They provide a ready market for the sale of commodities and incentivise the use of storage facilities (warehouses) which can help minimize post-harvest losses;
- Through grading and standardization of commodities, commodity exchanges promote high standards of quality thereby boosting export as confidence is strengthened in the quality of commodities exported through the exchange;
- Commodity exchanges provide risk management tools; enabling entities hedge against possible adverse development in the future prices of commodities. Such facilities help industries plan by providing price and supply certainties. Farmers can also use the market to hedge their commodities against adverse price fluctuation;
- They promote agricultural produce financing and development of warehouse receipts which can enables farmers including small holder farmers borrow against the commodities in the warehouse;
- Commodity exchanges provide reliable price benchmarks for non-exchange traded markets such as the Over – The – Counter (OTC) market;
- Through the use of warehousing, they help to ensure continuous supply of commodities regardless of the season. This guarantees raw materials for the industry at all times, reducing risk of production disruption as well as storage and production cost;
- Commodity exchanges can also assist in moderating consumer price because of their ability to drive up agricultural production;
- They provide opportunity for securitization of commodities through the warehouse receipt system, which can also be used as collateral to unlock finance from financial institutions;
- They provide opportunities for investment in the commodities value chain such as warehousing, assaying services, brokerage and logistics;
- They promote the development of derivative markets as derivative instruments with commodities as the underlying instruments are developed with the attendant benefits such as permitting farmers and others to hedge their investments; and finally
- A thriving commodity exchange can contribute to moderating and reducing illegal mining of solid mineral products as the exchange tracks and records the origin (source) of all commodities traded on its platform.
Commodities market can be broadly classified into the Cash or Spot Market and the Derivatives Market. In the cash market, transactions are conducted for immediate delivery of physical commodities or securities while in the derivative market delivery is at a future date. The derivative market can be broadly categorized into the forward and futures markets. The forward market trades in contracts of commodities and financial instruments which are for future delivery but customized to the specifications of the transaction parties. They are traded over-the-counter and not on an exchange.
In other words, a derivatives commodities market deals in financial contract between parties, which is derived from ascertaining the value of an underlying commodity. Because the derivative market relies on the price of the underlying market, it is essential that a strong cash (spot) market exists prior to the introduction of derivatives.
In the futures market, buyers and sellers agree on the quality and quantity of a specified commodity to be delivered at an agreed price and date in future. In the options segment, parties enter into contract that confers the right, not the obligation, of a buyer to buy or sell a given commodity at a particular price for delivery on or before a given period.
A major distinction between the cash and derivatives commodities market is that transactions in the cash market are usually carried out by buyers who have immediate use for the commodity purchased while transactions in the derivatives market do not often result in physical delivery as they can be offset before the delivery date.
Nigeria Outputs and Exports of Commodities
This subsection further underscores the importance of commodities in Nigeria, focusing on output and exports.
Tables 2-4 give the structure of Nigerian agriculture and mineral resources in terms of production (Gross Domestic Product), relative contributions to the economy and real growth rates.
It is depicted that agriculture GDP rose from N19.64trn in 2015 to N21.52trn in 2016. The GDP of agriculture stood at N7.2trn in the third quarter of 2017. In terms of percentage contribution, table 3 shows that Nigeria’s agriculture sector contributed 20.86% to the country’s GDP in 2015, 21.21% in 2016 and this rose to 24.44% in Q3 of 2017. The crop production sub-section of agriculture is usually responsible for about 90% of agriculture production while other activities like livestock, forestry and fishing contribute relatively lower.
Culled from www.sec.gov.ng