The role of farmers’ associations in commodity price risk management and commodity collateralized finance in

developing countries.

UNCTAD, Commodities BranchUNCTAD, Commodities Branch

Olivier Combe, Lamon RuttenOlivier Combe, Lamon Rutten

What is price risk?

For a producer it is the eventuality that prices will decrease at the date of sale

For a buyer it is the eventuality that prices will increase at the date of purchase

Lower incomesLower incomes

Colombian Mild Arabica price evolution from Aug 95 to Dec 96

163

141

132129

110

119

135131

134

143

133 135138

123128 129

126

100

110

120

130

140

150

160

170

Price CIF in US cents/lb for Colombian Mild Arabica (price in New York), month's average

Less protection against price risk

Higher domestic price fluctuation

The reasons which explain that agriculture in developing countries is facing price risk.

Liberalization trend

Structural adjustment

plans

GATT agreements

Borders more permissive

Lower budgets for agriculture

Disappearance of marketing

boards

Higher price risk

Farmers ’ problems

Urgent need of cash-flow

Difficulties of warehousing

Immediate sale after harvest

Lower price due to :-counterparty risk is high-information non available -bad quality of products-supply in excess-weak competitiveness for purchase

too few warehousesexpensivenesssocial pressureunusual

former loanstaxesincomes 1 or 2 times a yearnext campainsocial constraints

&

High price riskHigh price risk

To guarantee sale price before harvest even before tilling

Price risk management tools

At delivery payment up to 80% of the final

value

To fix a profitable price before the sale

Price risk management may solve some farmers’ financial problems

Solutions:Solutions:To fix a profitable sale price

Urgent need of cash-flow

allows allows

Producer

Association

Future sale

Producer

Association

Instantaneous delivery

Solutions :Solutions : Easier access to credit for the borrower and less risky for the lender thanks to warehouse receipts.

Delivery of harvest

Issue of a receipt which indicates:-quantity-quality

Production of the receipt as collateral

Agreement, harvests stocked will be realized after loan

repayment

Commodity collateralized finance may solve some farmers’ financial problems

1 2 3 4 5Urgent need of

cash-flow

Loanto

farmers

Bank

Borrower producers’ groupsellermiller

Warehousesinsuredaccountable forstocksprivate orpublic

Delivery of harvest

Issue of a receipt

Receipt as collateral

Mandate to release the stocksfor the buyer

Buyer

Sale of the stockedharvest in accordance with the receipt

Payment to the lender bank

Payment of the rest after reimbursement of

the loan

Solutions :Solutions : Warehouse receipts are negotiable

1 2 3Urgent need of cash-flow

Loanto

farmers

Bank

Commodity collateralized finance may solve some farmers’ financial problems

4

Borrower producers’ groupsellermiller

Warehousesinsuredaccountable forstocksprivate orpublic

Price risk management with a farmers’ association and a bank involved

Association

Bank Farmer

Farmer

Farmer

Farmer

Farmer

Delivery of harvest

Payment up to 80%at delivery

National or foreigner futures markets

Over the counter market

Hedging of price risk Higher payment at delivery

Forward delivery contract

Hedging on the future market:-purchase of puts-futures contracts

Sale of a‘price insurance’

OR

Price insurance or

forward delivery contract

Allow

Public

Example of a futures market and its components

Brokers

Clear brokers’ accounts

Clearing house

Market floor Trade according to their client’s mandate

Control trades andprices

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Public is:

-speculators-bodies which hedge-arbitrager

Roles of equal significance

Counterparty risk is absent from futures market

Public

Brokers

Clear brokers’ accounts

Clearing house

Market floor

Control trades andprices

give

man

date

s of

purc

hase

s an

d sa

les

Con

vey

orde

rs fr

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Requirements to use the market:

Example of a futures market and his components

- have a broker- have the legal right to deal in futures market- have sufficient cash-flow

?BankTraderAssociationFarmerGovernmental or para-governmental body

Trade according to their client’s mandate

Benchmark place for prices

Necessary environment for a sound use of such tools

Futures marketSpot market Associations

Government

Banks

Competitive

Numerous actors

Liquidity

thus

Information available universally and on a minute to minute basis

DemocraticAware of their members (standard of living, production..)DynamicUncorrupted

Sufficient training Reliability between actors(to limit counterparty risk)

Interested in financing agricultural sector

Efficient

Correlated

Appropriate infrastructuresfor trade

Have to promote above points by adapting laws, ...

Ready to invest in terms of training, involvement in markets,etc.

Essential:

How may farmers’ associations do to improve systems

Training farmers Limiting counterparty risk

Acting as an intermediary in warehouse receipt’s system

Providing price risk management opportunities

How to tradeImportance of qualityWhat are loan contractsHow to hedge

By applying social punishment to unreliable farmers Indicating dishonest tradersActing as a trader or a seller what improves reliability in trades

Associations with an adequate size can hedge their risk by themselves (enough cash-flow, reliability, volume to trade, etc)

Local banks are needed for smaller associations.In that case the role of the association is limited to strategic choices (which type of hedging, what volume will be hedge, etc) and not to technical choices.

By supplying an appropriate framework: :- negotiating contracts with the lender- selecting participants- managing formalities in order to incite banks to lend-borrowing itself on behalf of all its members

Association

To improve agricultural area means:

Knowing how to face the risks Easing finance

Building efficient market’s infrastructures

Stressing reliability between actorsTraining actors

Informing decision makers about the real opportunities of these solutions

Adapting institutional framework

Sponsorisé par la CNUCED

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