Medhat Nafei
It was not until 2004 that I first realized that we need to revive the commodity exchange in Egypt, which was set up in the 19th century and traded mostly in Cotton but got shut off after the 1952 military coup and remained dormant since then. Commodity exchanges (commodex) all over the world were skyrocketing then, with trillions of outstanding contracts, whether spot or future contracts. I remember that I was assigned by the chairman of Cairo and Alexandria stock exchanges (currently the Egyptian Exchange (EGX)) to investigate the legislative, administrative and technical barriers of the resurrection of the commodity exchange.
Fast-forward 13 years later and after several failed attempts to revive it, the cabinet finally announced the revival of the Alexandrian Bourse of Mina El Basal commodity exchange. Only they seemed to completely ignore all previous failed attempts to revive the Commodex and sidelined those who worked on these attempts for more than a decade.
A commodex to fit Egypt’s environment
After a long journey of research and study tours in the United States, Malaysia and Singapore, we finally came to a conclusion that the main obstacle against having a commodity exchange is the absence of a well-regulated commodity spot market.
Warehousing in Egypt is a mess and quality standards are not reliable in maintaining an active business, especially with global markets. This made it obvious that the best start of the commodex is a contracts market with no physical delivery at maturity; only cash delivery that is marked against market value in a sound international commodity exchange such as Chicago Mercantile Exchange (CME). This means that the delivery of tons of steel at the maturity of the contract shall only be done in cash and the value should be set by what these tons are valued at on the CME on date of maturity.
Lack of legislation key to failed attempts to revive the Egyptian commodex
On the legislative level, a comprehensive law to regulate derivatives and contracts was professionally introduced by Ziad Bahaa el Din; nobody knows what happened to this law. As a result of this lack of legislative framework and the absence of a clear owner of the initiative, many attempts to form some sort of partnerships with international markets to establish the Egyptian commodex have failed.
The Egyptian revolution of January 2011 only threw heavy shades of uncertainty on domestic markets; that means more risks and less ability to introduce new products and instruments to the Egyptian financial market. We froze exchange-traded funds, Sukuk and derivatives and crossed our fingers to keep the cash stock market up and running.
Few years after the revolution and 10 years from the beginning of the Commodex revival story, I had the opportunity to bring the initiative back to light with then Minister of Supply Khaled Hanafy in April 2014. He was open to suggestions and listened carefully to my proposal, supported with a detailed action plan to establish the Egyptian commodity exchange under the jurisdiction of his ministry. But every meeting with Hanafy turned into an opportunity for media coverage and public relations with no serious steps forward materializing.
Today, everyone keeps asking me about hyper inflation symptoms and the way we can effectively control prices. I can’t say more than what Milton Friedman has said about this issue: “We economists don’t know much, but we do know how to create a shortage.” Friedman then explained how this could be reached through setting floors and ceilings on prices. I proposed on one talk show many other solutions to price shocks, one of which is the establishment of a regulated commodity exchange where demand and supply adequately match on screens transparently and tick by tick.
That day a parliament member was on the phone with the talk show host and myself, he promised to raise the issue in the parliament and this is what I think he did. A few days later, the cabinet announced the revival of the old Egyptian commodex; the Bourse of Mina el Basal in Alexandria.
My greatest concern is that the cabinet did not mention in its announcement the previous efforts that aimed to achieve the same goal for more than 13 years. This means that they will not analyze and learn from previous failures or at least the causes of this delay. The cabinet did not communicate with the previous key players who were working formally with the state on this profile. So we reinvent the wheel each time we think it is important to have a wheel.
Why we need commodity markets
Commodity markets provide the financial market with the following:
•Price discovery: Commodity markets help discover the present and future price of any commodity or financial asset, which is an essential part of an efficient economic system. Prices of stocks and commodities tend to move in the same direction as the expectations of market participants.
•Risk management for organizations or individuals; financial uncertainties expose them to unexpected losses in many ways. Derivatives are instruments meant to cover risks. Corporate, traders and individuals use derivatives as a tool of risk management to cover the vagaries of price fluctuations.
•Speculative activity: Speculators, due to their volume of activity, drive prices in one direction and then in the other, causing upward and downward movements in prices. What drives them is not fundamentals but mass sentiments. Irrational speculators may get lost in the process, but, rational speculators would jump in on any mispricing in the market and this results in the price being brought back to equilibrium.
Commodity Exchange in Egypt can provide greater price stability by reducing risk and increasing the number of traders, trade volume and trade value and improve product quality because the market imposes grades and standards. It can then gradually increase trade profitability to all participants because of the increased trade volume and increased efficiency. This increased efficiency can result in higher income for farmers and lower costs to consumers. A commodity futures exchange acts as an important component of a privatized, open economy to help achieve the benefits possible from free markets and free trade. It can also capture some of the trading value on neighboring exchanges and serve a similar function as insurance for actors in the market through proper use of hedges.
What we need to have
First we need to have a proper legal framework, technological infrastructure and business infrastructure.
Several legal and regulatory elements must exist, including: 1) a description of purpose, authorities and responsibilities; 2) delineation of accountability and defined limits of independence; 3) defined systems of enforcement and cooperation; 4) systems for authorization or licensing of markets and actors in those markets; 5) rules established for the normal functioning of the market; and 6) rules established for exceptions.
The proper legal and regulatory environment and the supervision will ensure fair, transparent and efficient prices, financial integrity of brokers and contracts that are not readily susceptible to manipulation on an ongoing basis. It will also ensure the financial integrity of the market through an appropriate margin, risk management and clearing. A proper legal environment also means implementing a law that unconditionally supports the integrity of clearing arrangements and the treatment of margin by the clearing house.
Technology Infrastructure
The choice of technology infrastructure is a main pillar of active commodity exchange and has significant benefits in terms of transaction costs and market efficiency. The technological design, both in terms of hardware and software, should assume international market standards to ensure financial integrity.
The technology employed must support a trading system where buyers and sellers are unknown. It must also ensure international reach and equal access with order matching on price-time priority. It must also ensure a time stamp for each order and trade.
Business Infrastructure:
The business infrastructure must be provided through all these phases and fields, including: product selection, contract development, clearing and settlement, risk management and surveillance, warehousing and assaying, insurance, and delivery.
Scenarios for establishing the Commodity Exchange:
The first scenario for establishing a spot market as a network is establishing a well-organized network between the current under-constructed commodity exchanges in each governorate to facilitate trading of agriculture and animal products to fulfill the Egyptian government’s plan to establish commodity exchanges. The exchange will start with spot trading then introduce contracts trading.
The advantages of this scenario will be maximizing the benefits of current and proposed commodity exchanges for governorates. The exchange under this scenario would be fully owned by the government, represented by the Ministry of Supply and Internal Trade.
The second scenario would be establishing a private commodity exchange through a new, privately-owned commodity exchange as per section four of the executive regulations of capital market law 95 of 1992 named Private Stock Exchanges.
Finally, we need to understand at a glance the structure of commodity market in Egypt nowadays, before we go further with the long-suspended project of the Commodex. Agriculture is a critical and important element of the Egyptian economy. Approximately 30% of the population is directly involved in agriculture and half of the population lives in rural areas. Most of the farmers are poor farmers, operating farms of less than five acres (feddans). Ninety percent of farmers fall in the latter category. Furthermore, 80% work three acres or less. Of the 20% of farms larger than three acres, most are in reclaimed lands, fairly large tracts and are dedicated to perishable fruits and vegetables that are not suitable for trading on a commodex.
The construction market is very important and is suitable to be regulated in such an exchange, as it will help in hedging the risk of price fluctuations of the real estate market. Steel and cement represent about 50% of construction costs.
But, we must consider the possibility of having a very active commodity exchange trading products that are not produced in our country. Singapore is a good example of a country having a very active derivative market, trading palm oil futures and options, whereby the palm oil is produced in Malaysia. Egypt stands a good chance to be a regional hub for trading crude oil contracts extracted from the gulf area. Bt
Medhat Nafei
With a PhD in economics, Medhat Nafei is an expert at the Egyptian Economic Court and serves as the Egyptian Exchange’s general manager of the Risk Management Department and a member of its Supreme Executive Committee. He is also the vice chairman of the Sustainable Working Group at the World Federation of Exchanges.
Disclaimer: The opinions expressed in this article are the author’s own and do not reflect the view of the magazine or of any institution that he works for.
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