Changing world trade and settlement

“Solving the Commodities Problematique”
Colin Howard, Chairman, Comdaq Ltd.
6 April 2010
Table of Contents
“Solving the Commodities Problematique” 1
Table of Contents 2
1 Background 3
2 Objective 3
3 Executive Summary 3
4 Speculation! 4
5 National markets 5
6 International markets 7
7 The Comdaq Operating System 8
7.1 Initial explanation 8
7.2 Competition 8
8 Building blocks of the operating system 9
8.1 People 9
8.2 Rules 10
8.3 Rights 10
8.4 Login 11
8.5 Governance 11
8.6 Accounts 11
8.7 Portfolios 12
8.8 Risk 12
8.9 Counter party preferences 13
8.10 Summary to this point 13
9 Enabling market instruments 14
9.1 Depository receipts 14
9.2 Single stock, single quantity, future. 14
9.3 Trade finance 15
9.4 Settlement 16
10 How does that solve the problem? 16
10.1 Volatility 16
10.2 Declining prices 17
10.3 The concentration of power 17

1 Background
At the UNCTAD Global Commodities Forum, dated 22-23 March 2010, and in the follow up Multi Year Expert Meeting on Commodities and Development, dated 24-25 March, constant reference was made to the Commodities Problematique.
At the conferences the specific focus was on the damage done to society and the incomes of emerging nations by price volatility. Analysis further suggested that this impact was compounded by a declining trend in price realisation overall. However, the greatest concern surrounded the degree to which commodity markets were controlled and managed by a very small concentration of power by macro corporations.
Separately there has been considerable academic study, leading to the creation of the “All ACP Agricultural Commodities Programme”, supported by the EEC and UNCTAD, amongst many other leading NGO’s that recognise the link between production, value addition and trade in agricultural commodities and poverty reduction.
Under the auspices of the ACP Programme, a meeting of Experts was held at UNCTAD On July 9 - 10, 2008, leading to the presentation of a paper titled ‘Implementation Strategy of Commodity Exchanges’. As the title suggests, it was the conclusion of these studies that a structure of open and transparent markets was required to assist ACP producers to gain access to information and customers in order to increase the realisations from their labour.
2 Objective
This paper seeks to demonstrate how an effective market structure can be created to provide national and regional control of trade flows by ACP Countries as a counter weight to macro corporates, and to provide a resistance point to continually degrading prices. Further, that effective information flows will provide a basis for measuring the direction of price movements that may give regulators the tools they require to counter excessive speculation.
3 Executive Summary
Commodity markets that are designed to trade in physical goods break down into two interconnected, but otherwise diverse, spectrums. The Inter - Country market may be very significant, and relatively simple in that it is conducted in the National currency. Any surplus for export has to deal with many other hurdles.
In International markets, first there is a foreign exchange component which increases complexity and risk, not to mention compliance with National policy. Secondly there is the application of different legal jurisdictions, giving rise to contract questions, with enforcement being potentially complex and time consuming. Thirdly there is the need to create an arms length connection with a remote counter party, who may be an unknown quantity. Finally there are problems related to the timescales of remote trades, together with the logistics of delivery and the timely settlement of payments.
It is the assumption of this paper that both types of market adopt and embrace the advances presented by modern communications, together with computer support; with its associated measurement and information capacity.
Within a National market the actual “trade matching” can be relatively ‘low - tech’, yet use advanced techniques; and the options in this regard will be covered in detail.
The major question, to which we provide answers, is to provide a common global infrastructure that identifies and connects counter parties, provides securitisation and settlement processes, assists in the logistic support for delivery, and provides as comprehensive a guarantee to the trade - together with the management of risk, as is practicable.
The information flow from this structure will be comprehensive, immediate, and available for further analysis - giving rise to action if appropriate.
Thus a support structure will be created for internal trade, together with current price dissemination, supported by modern techniques that will increase local access to domestic markets. Countries will also have access to external buyers and producers for the purpose of exporting their production and importing requirements that will be an alternative channel to the macro corporate. Finally, comprehensive market information will provide a basis for the regulation of market volatility.
We believe these to be effective tools to resolve the Commodities Problematique.
4 Speculation!
The very word polarises opinion, and the subsequent separation into two “camps” is not helpful to objective resolution, so this subject must be grasped at the outset. It is our case that there are three associated realities (which will be defined individually below) that are inextricably linked. They cannot, as is so often the case, be used to counter one or the other of the components. There is no “answer”, it is a question of balance.
The first reality is that speculation distorts markets, and to suggest otherwise is simply the position of the interested lobbyist. Speculators are betting on the movement of the market, and that in turn influences its direction, sometimes excessively. The case against speculators will be argued passionately by those who perceive the activity to be getting rich at the expense of the poor, and contributing nothing in the process.
But the second reality is that speculators do make a contribution to the process, by creating liquidity in markets, and (during normal trading) creating the essentials for price discovery. Taken to extremes, the activity can be regarded very negatively, and this paper will suggest means whereby excesses can be constrained, so that the social benefit can be realised without the downside of extreme volatility that impacts jobs and incomes disproportionately. However, in a decently regulated market the speculator has a role to play, and the case for them has to also be rationally argued.
The third market reality is that prices fluctuate with varying supply and demand, and this is the foundation of the creation of price in the first place. Thus the process of “price discovery” could be defined as establishing the level at which 100% of the available supply can be sold. If there is a shortage then the producer benefits from the highest possible price, and that is the declared objective of the ACP project. If there is a surplus, then the marketing has to be carefully managed to avoid a price collapse, with a possibility of intervention in some cases. Advance information is the key to being able to take action.
Thus trading in “derivative instruments” that support the transaction in the physical product has two vital roles. In the first instance they can be regarded as insurance for both sides of the transaction, which can “lock in” a value that is acceptable to them. They may then miss some advantage as the price moves one way, but are protected from loss as it moves another way. As with all insurance, it underwrites risk and offers certainty, and that has a market value.
It is the speculator who takes on that risk, by backing his or her judgement regarding the direction of the market, and its level. Of course they do so with a view to making money, but their capital is also at risk to underwrite loss when that occurs. Because the derivative trades far more frequently than the underlying physical, it gives a much finer grained trend indication, meaning that markets would be significantly less efficient without the resource.
5 National markets
Because National markets generally have migrated to an electronic environment it should not always be considered that this is the only, or best, way to trade commodities, and may especially not be correct in relatively low volume production of agricultural commodities, especially perishables. India, for example, has invested heavily in market centres where goods can be taken, traded on an auction, open outcry or bilateral basis, and then share onward delivery transport. (Bangalore has a significant example.) This approach is probably far more appropriate to the literacy levels of emerging Nations farmers.
What then is the role of a “commodities exchange” in such an environment? In short, the answer is ‘structural’. Physical buildings are required, together with organisation, planning, resource allocation and - most crucially, data capture on the transactions effected.
That makes the “back office” functions the primary role of the modern commodities exchange. As well as a concentration on price, for the purposes of information distribution to assist producers, the collection of statistics are also important (Quality, quantity, variety etc.) Some products will require support, from either an insurance or inspection perspective. Others may benefit from the securitisation that a depository receipt can offer - with a hedge available as a derivative of that receipt. This role requires computer support, and staff familiar with the application of Information Technology.
One single piece of IT equipment has become ubiquitous in its use and acceptance, and is totally appropriate as a “terminal” within this environment - namely the cell phone. The writer has seen these used most effectively in Maharashtra State, India - where the major spice traders negotiated bids and offers over a mobile. They were effective, rich and successful, despite none of them ever having been taught to read or write. Education and intelligence is not the same thing, and simple messaging can be learned quickly to assist illiterate users.
Because “inter country” trade will probably dominate where agricultural needs are concerned, then this has to be considered the prime role of the exchange. However, there is a very important second aspect, whose volume may in some circumstances be significantly greater than internal trade, and that is to act as a conduit for the export of goods and the importation of requirements.
The next section will deal with international trade more fully, but before we leave the National scene, certain points should be made. First, it is probably in the interests of most emerging countries to have some form of control point that provides Government with leverage over the assets that make up a dominant percentage of their economy. Without a “portal” of some sort there is a chaotic information environment, with no real measurement, that may be manipulated by macro corporates to their own advantage. This is true of both the possible undervaluation of the export of assets, and also the extra cost of a non competitive supply position for requirements. An open and transparent exchange has clear merit over an opaque and self interested market mechanism, especially in the capture and redistribution of information.
The second point to be made is that the market should embrace all commodity assets, notwithstanding the concentration on agricultural commodities that becomes the natural focus of most producer countries, and the specific brief of the ACP. For example, Jamaica has an important export trade in spices and peppers - as well as a large domestic consumption; but one of its largest employers is within cement production which has a potentially larger export value. Structurally, and as far as the “back office” is concerned, all commodities have the same characteristics - so the view should be taken that one exchange copes with all requirements.
Finally, there is an assumption that “information” also allows interpretation. With the rush to free trade, and the abandonment of controlled pricing, the corollary was meant to be unrestrained growth. Can anybody say that happened? A cynic may say that the strong became stronger, and the weak weaker. The flow of data from an appropriate collection point also allows appropriate organisations to both plan and respond to input dynamics. “Surplus” may be managed by withdrawing product from the market, either through storage or alternative processing. “Shortage” can indicate an opportunity for investment. Active support can also be available for the opening of new markets, or sources of supply in the search for “value addition” that is seen as a solution to poverty by the ACP and their supporters.
(Note that, in large countries, there may be many physical centres that can be connected by planned logistics. However, only one “back office” system can serve all the locations.)
6 International markets
The same National commodities exchange can have an external facing role where it has four functions. The first would be to ensure the orderly export of all available asset commodities that can be spared from domestic consumption. The second is to provide a managed focus for the import of requirements, on the best possible terms. The third is to ensure that any conditions attached to either an import or export are tracked and managed. The fourth is to direct investment and production to the long term benefit of the community. Some countries may have a fifth need, namely to manage foreign exchange allocations.
To repeat the fact that the focus of the ACP programme is a concentration on Agriculture, and to stress that there are countries that export food and staples as part of the agrarian economy who can maximise returns through an exchange structure. Equally, there are countries with a food shortage, and the ability to source that food from nearby sources at lower transport costs also contributes to a relief from poverty, as well as providing a “carbon miles” benefit.
However, it is our case that any National exchange can use its single structure for all its commoditised export and import needs. We have already instanced the cement production in Jamaica, a second example would be the intention of the Government of Trinidad to seek wider and better trading for its oil output. (When considering this external role, it is likely that there will be a network of traders within the relevant country, who may have trade relationships with each other. In this case they must operate as an external market, using the agreed world currency. There is no current facility to switch between national and international markets.)
To achieve relevance on an international scale each domestic market has the same infrastructural requirements. The first is the widest possible access to appropriate counterparties with whom to trade. This must be backed up by a common and agreed form of rules and discipline that can ensure and guarantee the product quality, delivery and settlement process. Sophistication is added by the ability to securitise a commodity in a form that can be traded other than “spot”. This allows the addition of the sale of “forward” contracts, generating the cash flow to producers that are attached to a “future”, providing the insurance component and price guarantee of a “hedge” and the ability to pledge stock against trade financing.
The considerable complexity of the delivery challenge to provide this structure will be enlarged upon in Chapter 8. Recent technical advances in both computing and communications have made it possible.
7 The Comdaq Operating System
7.1 Initial explanation
The term operating system is used to explain the purpose of the infrastructural layer to a community that will be familiar with its function within a PC. It can be regarded as the essential “glue” that makes everything interoperate, yet is not the executive program itself. Thus National exchanges, or interconnected customers of any sort, are entirely independent in their management and direction. However, each needs to follow the architecture of the interconnections provided by the operating system in exactly the same way as the Internet has to follow the use of structures such as TCP/IP laid down by the founding fathers of the Internet.
7.2 Competition
Comdaq was founded in 1999 as the first initiative to seek to deploy the Internet as a tool to facilitate commodities trading. Since 2003 it has consistently contributed to the thinking and planning of UNCTAD, and been a beneficiary through exposure to the considerable expertise within the Commodities Unit - plus associations in the field with organisations such as FAO, ITC and USAID.
We are a commercial organisation, whose founders have a long history of delivering social change through their work. We have the belief that the purest form of entrepreneurial activity is to identify a need, and by investing time and capital to satisfy that need and earn a return.
In this case we are setting standards, creating benchmarks, defining interconnects and structuring systems approaches in the same way as the previously mentioned originators of the Internet did. E-Mail works because the entire network subscribes to the Simple Mail Transport Protocol (SMTP), even though many organisations run independent servers.
Comdaq sees its future global role in the same way. Having invested in the sector, it will seek the widest possible commercial exploitation through contracting its capability to independent exchange structures. However it must equally be “open” to an interconnect agreement with any other operator who can deliver a competency to an equal standard.
There are several examples of competition existing within cooperating networks, with the interconnects between mobile phone companies being one that is easy to identify because of the world scale of their reach. However, perhaps the most relevant example, because of the related management of risk and exposure, is the credit card companies, whose international acceptance can only work through a common infrastructural agreement.
8 Building blocks of the operating system
(This chapter deals in outline with the individual component considerations that have to be brought together in order to create the underlying infrastructure. The actual design specifications are very detailed and each heading would be of “paper” length in themselves which may obfuscate absorption of the principles. Comdaq will be pleased to elaborate on any subject heading to explain the precise modus operandi of deployment.)
8.1 People
Notwithstanding considerable use of computing expertise, the starting point remains an individual. Comdaq are hosting an independent generic database called the Registered Persons Identity List containing the details of all participants in markets, whether they be traders, brokers, administrators, auditors or any other involvement. This will be “open” to other networks. (RPIDList.com and RPIDList.net; the URL is deliberately obscure, it is only of interest to market participants.)
From the individual point of view this database will be a single point of contact that will allow access - via secure logon procedures - to any and all markets to which he or she is granted access rights.
From the “markets” point of view, a link to the RPIDlist will generate pre-approved access to the entire community. Thus a Tier 1 banker may, should they wish to, gain access (subject to the exchange approval procedures) to a newly created market without seeking additional logons or going through the process of confirming that they are “fit and proper” within the meaning of the regulations. (See 8.2).
From the participants perspective they can take on, or indeed remove, a trader or broker with a keystroke that allocates (or removes) their associated rights. (See 8.3)
Most important of all, from a discipline point of view, a complete career history is recorded. The existing “phone broked” international market is rife with defaults, cheating on quality, settlement delays, and occasionally outright fraud. The only real solution to the temptation to “take advantage” is first to have clear rules, and secondly for there to be an effective sanction if they are broken. Knowledge that any bad behaviour will be permanently recorded on the RPIDlist should be a powerful deterrent.
8.2 Rules
Operating rules may vary from market to market, but they will all have the same underlying objective, which is to apply discipline, order and respect for process within the transaction. The purpose of rules must be to get as close as it is possible to get to a “guarantee” - supported by relevant risk instruments - that a bargain that is agreed will be delivered and settled to an agreed quality standard. The operating system maintains a “workflow” awareness of the underlying position, alerting either side by ‘exception report’ if any element is out of line.
The really important issue is that the exchange structure becomes a “Self Regulating Organisation” (SRO) which applies its own regulation over and above National law. Of course it always respects the law of each participating country, but it is supplemented by compliance to the code of the markets in which the transactions are being contracted. Furthermore, all members must agree to be bound by the rule book, meaning that there is a “common” law that applies to all. If any side of a bargain then seeks to leverage a position by hiding behind some local anomaly, then they will nevertheless be disciplined by the Exchange and that action permanently recorded.
8.3 Rights
We have explained that individuals have specific roles in the market, and that their behaviour is guided and constrained by rules. The next control layer to be added is their “rights” in the market. Most specifically this applies to the member who is working for an organisation. They will wish to control their risk exposure by setting transaction levels and authority limits, and maintain an awareness of their position at any one instant. Allocated rights are set and managed by the appointed administrator of the employing organisation, who can cancel them at any time, either by individual, or across the entire business. The company remains responsible to close off any open issues, but they can stop any further exposure whenever they require to do so.
Rights to a market, or to deal in a particular instrument, are also set by the administrator of the relevant exchange. Similarly these rights can be withdrawn at any time, normally only when a default of some kind has occurred as a sanction to ensure compliance with the rules.
8.4 Login
The profile of markets accessed, commodities traded, and associated rights are all maintained by the access table - reached via the secure login process. Very comprehensive security is applied to each level, with the most fundamental being the “retail” access that can view information only. Each extension of a trading level has to pass further tests, both of data confirmation (the rights table) and the identification of a known machine for the input using the MAC address. We will not describe the methodology here, but when it comes to inter communication between approved counter parties the security environment has to be absolute and mission critical.
8.5 Governance
Most transactions will always follow the same path, which we call “workflow”. Software can monitor the passage of the trade and providing nothing unexpected happens, it can flow through to completion without any external involvement. Specifically there is no administrative cost of “checking” something that is perfectly in order.
Equally, the software can identify something that is unexpected in an instant, and alert management to an investigative need by means of an “exception report”. Staff support can thus be focused solely on matters that require attention, with no delay. The problem may be temporary, or terminal, but either way the exchange benefits from the earliest possible resolution by the governing body.
8.6 Accounts
Much of the governance, and monitoring of the workflow, is achieved by having a “100% audit of all data of numerical consequence 100% of the time”. The software basis is a relational database management system (RDBMS) that both sets and maintains relationships between the various input components at all times. Volumes of an instrument or commodity are normally the starting point, but of course those can vary in negotiation. A value has to be attached to make it a trade, and that may be complicated by requiring a currency exchange component, managed by a hedge at a fixed value. Any extended value has to fall within the rights parameters to allow the transaction to progress, and that must be notified to the counter party so that an assurance can be given that the required finance is in place for the bargain. At this stage there may be crossed derivatives positions to be unwound as part of the settlement. Most of the time it is routine double entry book keeping, and the presumption is that the process can only advance to the next stage if the previous stage is in balance. As in governance above, any variation from the “norm” should be picked up immediately, and be subject to investigation and management action.
8.7 Portfolios
To maintain these positions each registered person has an allocated portfolio representing either cash or stock. It is within this environment that the numbers layer checks that no limits of their allocated rights are breached before allowing a trade to progress. A trader has full access to his or her position at all times through this medium.
Managers of an organisation have a (read only) view of all portfolio entries to which they are exposed. They can view on the basis of an individual trader, or that of a consolidated position of the entire firm. This latter view can be exported to facilitate proprietary analytics if required.
A return feed allows a manager to pull all, or a selected list, of uncontracted bids or offers. These may be replaced in the market in an unchanged form, only if no other activity has taken place in the meantime. If there is any change to any element of the bargain, then this has to be re-entered by the authorised trader. This is also true if the trader has posted any other trades.
8.8 Risk
It will be obvious to readers that every layer so far has been building up to the control and management of risk. The individuals have to be known and verified as “fit and proper persons”, agreeing to be bound by a set of operational rules, with allocated rights that are confirmed via a secure login process, all enforced by a governance competence, measured by a comprehensive and balanced accounts layer that is presented to the trader and manager as a portfolio view.
Risk however will mean many different things to different people. The exposure that an exporting firm may have in marketing a quantity of a commodity is going to be different to the speculator investing in futures through the structure. Except in one sense, that will be covered later, it is up to the member to manage their own commercial affairs, including their market risk. The role of the market is to ensure that no trade exceeds authority limits set by the administrator, and that the trade moves through the process in an expected manner.
However, that cannot be the end of the matter. Within its membership criteria the exchange must have a full understanding of the capital capacity of the involved parties, and have a right to “view” the position of any element at all times. It is then the responsibility of the exchange to set its own position limits on the activity of the firm (or trader) concerned, and require further capital cover to be deposited in the event of a recognised loss or uncovered open position.
The most obvious “micro” example of this requirement would be in the case of a speculator in futures who suffers a run of losses leading to a margin call. If they cannot pay, then their position has to be liquidated as early as possible. Whilst it is unlikely that the same problems would befall a major firm, recent world events have suggested that it is possible, making careful control of risk a prime duty.
8.9 Counter party preferences
One of the features of the RPIDList is that participants can check whether another person is a counter party with whom they are happy to do business. Bids and offers are negotiated anonymously, but if the trade has been entered by an approved counter party then it is presented in a “hard” colour, meaning that negotiations can be entered into immediately.
If the trade is seen in a “soft” colour, and it is of interest, then a process of discovery is required via the exchange broker to put a deal together. Normally this leads to the establishment of a new relationship as an approved counter party.
Only those participants who are confirmed as having an approved relationship can communicate via the trade messaging facility (including VOIP), or reach each other using the platform’s secure email feature. These are all designed to be very high security, and appropriate for trading purposes only.
8.10 Summary to this point
Having added the counter party preferences to further add to the control of risk, that concludes the presentation of the infrastructural layers of the operating system. It will be seen to be comprehensive, detailed, and essential to the creation of a framework that all participants can use and trust. We must now present how the enabling instruments fit above that layer to add to the process capability.
9 Enabling market instruments
9.1 Depository receipts
The securitisation of a product via the use of a depository receipt relies on two assumptions. The first is that the product is in a secure environment that is trusted to maintain that security. The second is that there is an independent agency (normally an inspection service) that can warrant the quality and quantity of the commodity.
Please note that the more familiar description term is as a “warehouse depository receipt”, and where there is a properly managed and secure warehouse structure it can be extremely simple to gain full benefit from a WDR. However, there are many other acceptable situations where receipts can be created and deployed, such as an oil tanker, or tank farm, or grain silo. Equally, there are some products, such as iron ore or cement, that can never be packaged in a tidy manner, but which can nevertheless be securitised. Extending the example of iron ore, if an inspection firm can confirm that a storage pile is in excess of 60,000 tons (the capacity of a Panamax), and that the fee is in excess of 60%, then there is no reason why that should not be securitised.
The benefit of a receipt is that title can be exchange traded in the same manner as a share certificate is sold, and indeed the Comdaq DR program follows closely the mechanisms of our stock exchanges. The issue of the certificates are subject to a central (dematerialised) registration, with the underlying ownership credited to the relevant stock portfolio. Transfer is crossed on receipt of funds so that the cash portfolio is credited, debit stock portfolio, and having the opposite result on the portfolio of the counter party.
Collection may then be authorised - in which case the transport company is issued with a delivery receipt, and that can be tracked until it becomes (perhaps) a bill of lading, and maybe title to the product can still be exchange traded at any time. Securitisation thus becomes a sophistication, complementary to a procedure that can operate as a simple quantity of inspected product, entered as an offer, on an exchange engine. But see next instrument.
9.2 Single stock, single quantity, future.
Readers will be aware that there is limited futures support to many products, on the basis that there is no structure for them to be “delivered” if the future goes to maturity. That is not the case with a DR, because the specific quantity, of a known quality, is already in a deposited environment. It may be 200,000 tons of Brent Crude in a tanker anchored in a world port, but it can be taken possession of, and moved. (In this example!)
This dramatically changes the emphasis and nature of the investor taking a position. Indeed, it might be considered to be returning to the original purpose of a future pioneered in Chicago, that of providing interim financing for aspects of the trade cycle. A future issued on the back of a depository receipt can become a far more useful trade support product, whilst continuing with its prime role of giving an indication of the direction of price as a form of value discovery.
Speculators will be giving buyer and seller a genuine “hedge”, akin to an insurance guarantee for value - and earning a premium in the process that adds value to the transaction, it ceases to be simply a “zero sum game”. Furthermore it can be used as a contribution to settlement, if one side buys and the other sells a market quoted future, then the balance of value due on delivery becomes much smaller, making trade finance easier to manage.
9.3 Trade finance
It is within this area that the greatest potential exists for a paradigm shift in international trade, with a huge impact on costs.
Currently the industry still clings to the “letter of credit” that has seen little change since the 16th Century. It is a flawed concept, with many examples available of default due to a failure within the legal clauses. It is very expensive, costing up to 2% (and sometimes more) of the value of the transaction. However, the greatest cost cannot be measured in economic terms, and that is the consequence of the parties failing to consummate the bargain.
In this regard the biggest enemy is “time”. Any exposure to time risk means that the pricing upon which the bargain was based cannot be sustained. Taking iron ore once more as an example, it is likely that the ex mine price will change on a daily basis. To what degree will this change before the mine owner revises his price? If it has gone up by even 1%, it is likely that there will be change - which may be absorbed within a brokers margin or principals pricing; but margins are tight on these trades, and 3% will certainly see a collapse. (Of course it is going to be the end buyer who pulls out if they perceive they are over paying as prices reduce.)
But the headline price of the commodity is not the end of the “price/time risk”. The ore has to be trucked from the mine to the river. It is then loaded onto a barge for transhipment to the Panamax, which must have an offloading berth booked at the destination port. Putting a deal together is like building a ‘house of cards’ - with a delicate balancing act resting on a similarly insecure foundation - and it only takes one price change, or a strike, or a weather change to knock everything sideways.
Thus very few deals survive the sometimes fourteen days that a letter of credit can take to negotiate. (It should be acknowledged that the industry does have techniques to shorten these time scales, and established trade structures will operate much more efficiently, but in the main we are considering the introduction of new participants who have to create new relationships in the market; and for them all these problems will apply.)
The solution is to use the medium of the bilaterally negotiated online contract as the basis for what might be termed (to facilitate understanding) an electronic letter of credit. There is no reason why any and every conceivable clause can not be added to this contract, to cover any issue that can be created on paper. Furthermore, the aspect of securitisation can further mitigate risk, as well as the information flow, and the known relationships with approved counter parties.
Indeed, the information available is such that it can allow new entrants into the relatively profitable and low risk area of trade finance - since suppliers do not require the wide ranging physical retail network to support the transaction. Competition, speed, and reduced processing costs will lower charges and increase efficiency in a manner that should alone improve commodity returns by 2% or more.
9.4 Settlement
The final link in the chain. We have seen how the operating system can ensure that responsibly governed participants can agree to trade bilaterally and enter into a contract for a securitised product, with practical support from relevant derivatives instruments. We have also seen how the time risk can be removed from the transaction, introducing new and improved payment options. These procedures and instruments get as close as it is possible to be to a “guarantee”, and that is the pre-requisite that will allow new entrants to participate in what has been a closed shop.
10 How does that solve the problem?
10.1 Volatility
If this is the most important question, then let us take that first. We would make the following statements.
First, in order to begin to start to influence events, then you have to be a participant. An investment into the control infrastructure by ACP countries, that gives them a management oversight of both national and international trade; that is connected to the enabling operating system described in this paper makes them a “player”, not a spectator.
Second, access to the information flow, indeed the ability to influence the information, gives not only advance warning of change, but the opportunity to consider policy to counter it.
Third, if it is the view that the market is headed in an extreme direction, then participation within the control instruments can not only correct that trend, but possibly generate significant profits. (OPEC is just one example of an organisation that has used its power to manage price.)
The final point to make is that current markets are imperfect, whatever the contrary claim by purists. On almost every occasion there will be spikes, with both high and low extremes, often driven by inexpert participants who manage to convince themselves that prices have become a one way bet. Almost always they lose, but not before creating great damage.
The experience of OPEC in damping these extremes should be studied to find a basis for regulation. In the meantime, becoming a part of the control levers that have a capacity to influence provides the opportunity for correction. Further examples are the manner in which the Chinese controlled the price of Iron Ore in 2007 and the Indian experience with sugar prices in 2010.
10.2 Declining prices
Since this has been defined as a long term trend, is it possible that the infrastructure described in this paper can reverse that? We cannot answer that, but we can ask three further questions.
First, can a cohesive network of exchanges deliver a greater proportion of the available value to the producer?
Second, is the price charged to the ultimate consumer declining, or increasing? If the latter, how can a delivery and trade infrastructure squeeze the margins of middlemen?
Third, will society continue to be driven by the demands of the rich “western” consumer, or acknowledge the needs of the producer? Who has the power? (Right now, the ‘supermarket’ buyer, combined with the macro corporate, holds all the cards. It needs a concerted move by producer nations to change that balance of power.)
10.3 The concentration of power
Whatever the answers to the questions of volatility and declining prices, the answer to the concentration of power can be approached more optimistically.
We are creating the mechanism for communities to take control, to participate in power. It will take time, and there will be many challenges, but the proof that it is likely to succeed is evidenced by the manner in which the “establishment has clung to traditional methods, including paper as a means of settlement in the information age.
The macro corporates cling to their opaque control, and are terrified of open and transparent markets. Thus making the strongest possible case for their adoption by the emerging world.
They are the key to solving the “Commodities Problematique”.
Source Colin Howard, Comdaq Ltd

Main Menu

See Also

Main Menu