If you go back 150 years, Calcutta, India was more advanced than Chicago,” says George Ferguson, who 30 years ago founded an import/export business called Chicago Midwest in part to spread the understanding of markets in the developing world.
“If you go back 20 years, Zimbabwe was the breadbasket of Africa,” he adds, pointing out that Calcutta lacked free and open markets, and Zimbabwean dictator Robert Mugabe scrapped his country’s nascent futures exchange after the market began to reflect rising prices, while Chicago became the world’s futures trading hub and the capital of the American Midwest.
“I’m not going to sit here and tell you that futures exchanges create economic growth,” he concedes. “But they are part of the equation.”
Ethiopian economist Eleni Zaude Gabre-Madhin won’t argue with that. After three years of intense wheeling, dealing and lecturing, the World Bank vet finally got the Ethiopian Commodities Exchange (ECX) off the ground in April of this year and she believes it will help her country weather the current food crisis.
“We’re following the Chicago model,” she says. “The early Chicago model, the one they started more than a century ago with a cash market, and regulated warehouses, and certified inspectors, and the involvement of farmers and producers, and with real price transparency, real price discovery, and real risk management.”
Meanwhile, two other fledgling efforts are taking shape across Africa, while the South African Futures Exchange (Safex, now part of the Johannesburg Stock Exchange) continues to go strong. But the biggest emerging market stories outside Asia come from Latin America.
For sheer quirkiness, the most interesting Latin American exchange arguably remains Argentina’s, which continues to pioneer the use of derivatives as financing mechanisms for farmers (see “Emerging markets: The next generation,” Futures, June 2005). But for traders, the big stories are Brazil’s BM&F and Mexico’s MexDer, both of which have become more accessible to U.S. traders since we last examined them in depth (see “Boom time South of the border” Futures, June 2006).
Both, for example, have demutualized and merged with their national stock exchanges, and both have entered into cooperative ventures with “big brother” exchanges, one in the United States and one in Spain. For traders, it all boils down to accessibility: By September, both exchanges will have woven their platforms into the global trading apparatus, making it as easy to trade São Paulo as it is to trade Chicago.
BM&F remains Latin America’s behemoth, but 10-year-old MexDer has always been out front in the internationalization department, largely because BM&F didn’t have to make the effort, thanks to its massive domestic market.
MexDer’s “big brother” exchange is Spain’s MEFF, which took a 7.5% stake in MexDer in 2003 as part of a technology-sharing arrangement that gave MexDer options trading capabilities. That same year, the exchange added IPC options to its IPC futures, interest rate products (the benchmark 10-year “M-10” and the 28-day TIIE being the two most liquid) and currency products (the peso/dollar cross).
All contracts are peso denominated, and the challenge now is to attract more diversified volume. A whopping 92% of the exchange’s volume is in the TIIE, giving MexDer a product profile akin to that of Eurex when it was dubbed “the Bund Exchange.”
Three years after MEFF took its stake, MexDer embarked on the second phase of its upgrade.
“Back in 2006, it was clear that we needed more participants, and that we weren’t necessarily going to get them from Mexico,” says Chief Executive Jorge Alegria. “We started talking to algorithmic traders like Timber Hill and Interactive Brokers, and they started telling us what we would have to do to attract their business.” The algo traders told them that technology wasn’t enough – they needed direct access from outside Mexico, as well as lower costs.
“We started talking to regulators, and basically figured out that, because of the way the laws were structured, we could offer direct access to derivatives traders, although equities traders would have to go through a local dealer,” Alegria says. “So, basically, the first problem was solved, but the second problem was a bit more difficult.”
That’s because the costs involved weren’t exchange fees. They were income withholding taxes that MexDer began lobbying the government to have removed.
The tax was lifted on fixed-income futures in 2006, but the tax on equity index futures remained until this year. Alegria says it’s no coincidence that 36% of IPC volume is now coming from outside the country, as opposed to just 15% before the tax was lifted.
MEFF’s shares in MexDer were swapped for shares of the holding company that now owns MexDer and Bolsa Mexicana de Valores (BMV – the Mexican Stock Exchange), which floated shares in June.
BM&F’s “big brother” exchange is Chicago’s CME Group, which took a 10% stake in BM&F last year, just before the exchange went public. Like MexDer’s hook-up with MEFF, BM&F’s CME deal supercharged its technology — specifically, its existing link
“The government had passed a pair of resolutions through the years that make it easier for foreigners to trade in Brazil,” says Paulo de Sousa Oliveira Jr., the exchange’s chief business development officer. “We wanted to fast-track that.”
The resolutions echoed those passed in Mexico: Brazil abolished the withholding tax for people trading on BM&F from countries that have tax treaties with Brazil (of which the United States is one) and also made it possible for non-Brazilian companies to open omnibus accounts, which reduces bureaucracy.
Like MexDer, BM&F has restructured over the past year, merging with the São Paulo Stock Exchange (Bovespa) to form a massive trading entity – BM&F Bovespa, the third-largest exchange overall in the world (behind Deutsche Boerse and CME) and the fourth-largest derivatives exchange, with average daily volume of 1.7 million contracts. After the merger, CME’s 10% stake in BM&F became a 5% stake in the larger company, and CME Group CEO Craig Donohue now sits on the board of BM&F Bovespa.
Astonishingly, BM&F managed to achieve this size despite being slow to embrace electronic trading and being slow to court international and algorithmic traders.
“Brazil is a big country,” says Oliveira. “We’re primarily geared toward local investors, and until now haven’t become fully electronic — at some point along the line, you need to use a telephone and talk to a broker.”
That all changes in September, when Globex members around the world gain direct access to BM&F. One month later, BM&F members will gain direct access to Globex – opening the door to arbitrage opportunities.
The exchange lists a diverse array of commodity products, some denominated in dollars, and accepts margin in dollars for all agriculture products (margin for financial products must be in real).
Nearly two-thirds of BM&F’s volume comes from interest rate products, and a quarter
from FX. Equity index volume (primarily on Índice Bovespa) more than doubled in 2007. Since 2002, volume has more than quadrupled, and volume from outside Brazil has gone up twelve-fold – topped off by a 73% surge in 2007, to 71 million contracts on the year, or an average daily volume of 290,000 contracts.
AFRICA: MOVING SLOW
Africa has launched a score of commodity exchanges since liberalization took hold in the 1990s, but only two are viable today: Safex and ECX.
“If any place needs futures exchanges, it’s Africa,” says Eric Tande, a native of Cameroon living in the United States and running a company called Makuna International. “But you first need the foundation. Go to Cameroon, and you see that food is being produced but more of it gets eaten by bugs and animals than by people, because there is no structured storage or distribution network.”
He says a lack of infrastructure is the biggest impediment to launching a successful commodities exchange, but adds a litany of contributing factors: small, fragmented economies tied into inefficient, graft-greased governments, and often dependent on just one or two export commodities that already have established benchmark products.
“We’re addressing all of these issues,” said ECX’s Gabre-Madhin at a conference in Geneva last year sponsored by the United Nations Conference on Trade and Development (UNCTAD). “Most of the efforts to build a commodities exchange in Africa put the cart before the horse – they tried to launch futures before cultivating a spot market. We’re not doing that.” Instead, her exchange created a unique spot market – essentially a futures market with 100% margin and immediate delivery.
“That is why we say ECX is the first of its kind,” she says. “Many of the emerging exchanges, who have started only as futures markets, are now facing the problem that the spot market is not aligned.” She says the small-scale farmers who produce 95% of Ethiopia’s food don’t deal with intermediaries beyond their local markets, leaving them at the mercy of dealers who know the value of a good lentil. Because regional markets tend to have wide variations in yields, prices vary across the country – and middlemen cash in at the expense of farmers. “When farmers can sell their crops on the open market and get a fair price, they will have much more incentive to be productive and Ethiopia will be much less prone to food crises,” she says. “ECX allows farmers and traders to link to the global economy, propelling Ethiopian agriculture forward to a whole new level.”
The Ethiopian exchange has a trading floor in Addis Ababa, six warehouses staffed by U.S.-trained inspectors, and 20 remote trading rooms where farmers at local markets can see central prices. Trading is being phased in slowly – the exchange started with corn, wheat, sesame and pea beans; later it will add coffee (Ethiopia’s top export) and teff, a local staple.
Rod Gravelet-Blondin says ECX is on the right track, and he should know. He runs the continent’s only successful commodities exchange to date – Safex.
“Everyone talks about our contracts, but it’s our infrastructure that really made us successful,” he says. “It’s ironic, but our infrastructure is a legacy of the Apartheid days, when the government was worried society would collapse at any moment. To secure the food supply, they built grain elevators.”
Safex also has the only white corn contract in the world and does a respectable 100,000 contracts monthly, as well as futures on yellow corn, wheat, sunflower seeds and soybeans. Two other exchanges are in the works – both following a hub-and-spokes model.
he first, PACDEX (Pan-African Commodities and Derivatives Exchange) has been in the works for more than three years and was set to launch in late 2007. The current plan is to build a hub in Botswana, with regional exchanges in various other countries. “The hub will house the trade-matching engine, while the regional exchanges will be subject to local regulations,” says Anthony Addendorf, who is spearheading the effort. The other hub-and-spokes exchange is MCX Africa, an effort being launched by the Multi-Commodity Exchange of India (MCX). Spearheaded by former UNCTAD commodities specialist Adam Gross, the exchange will probably have its hub in South Africa.