Commodity Spot Trading

REGULATIONS IN SPOT TRADING: International Perspective

TABLE OF CONTENTS:

Legal and Regulatory Environment for any Exchange

An important role for the international community will be to assist governments in putting into place a proper legal and regulatory framework for commodity exchanges as well as WHRs. Successful regulation is a matter of balance, and regulatory flexibility is key to the long-run success of commodity spot markets.

There can be at least three conflicting interests in regulation:

Client interest: Clients generally want an exchange that is safe to use and that generates prices that really represent underlying market conditions (Price Discovery mechanism of Spot Markets). But while they would like the exchange to be well regulated, they may dislike regulatory intervention in their own operations. But yet regulations are necessary for customer protection.

Government interest: The government has a broad interest in avoiding manipulation of exchange prices by a small group and in ensuring that the exchange does not collapse. Therefore, the Government has to play a major role in determining that spot prices are in accordance with supply and demand conditions of the market and the spot prices are not manipulated for by any group whatsoever for their own advantage.

Exchange interest: Exchange owners and managers would want enough regulation to create client trust but not so much regulation that operations are disrupted. Therefore, exchange owners should see to it that regulations do not hinder the day to day operations of the exchange yet maintain proper regulations so as to safeguard interests of all stakeholders.

How should regulations be formulated?

• An agricultural spot market requires rules for customer protection. Towards this end, the regulations could include procedures to ensure the fitness and competency of those who deal with customers, appropriate disclosures to customers, documentation to ensure customer authorization for transactions, sales practice rules intended to prohibit misleading sales conduct, segregation rules that require the separation of customer funds from the funds of the firm and rules that require that customers’ orders get priority over firm orders.
• The most successful exchanges are those that trade not only agricultural products but also other commodities and currencies and securities as well. Regulators should allow commodity exchanges to trade a broad range of instruments, including currencies, electricity, interest rates and securities. Therefore, exchanges should diversify their product offerings in order to minimize the risk and to be successful in the long run.
• Regulations for WHR system: Electronic WHRs and their transfer/sale through electronic means should be recognized by the law in the countries the exchange operates in. Many exchanges in ECA (Europe and Central Asia) countries have implemented WHR systems. Where successful, these projects have much improved the access of farmers, processors and traders to formal sector WHR finance at rates that are attractive as compared with alternative lending mechanisms. International agencies and other exchanges should build on the lessons of these projects.

Those looking for an exchange initiative also need to identify the peripheral policies and regulations that may be highly relevant for the chances of success of an exchange initiative

• Subsidies or tax rebates could be made available only to those farmers who sell their products through an exchange. This practice increases the number of transactions that happen through an exchange.
• Taxation can also be a problem for exchanges, in particular if paper transactions are taxed as if they were physical ones. If WHRs are traded, taxes should be levied only at the moment of original delivery and/or the final taking of delivery: in between times, trade should be completely free of registration fees, value-added taxes or other impositions (apart from a very low transaction fee charged by the exchange). This again increases the benefits of trading through an exchange
• Banking regulations in many countries do not allow banks to engage in activities such as commodity trade, commodity storage or the packaging of instruments offered on the exchange for a wider public of investors. These regulations are all potential hindrances to a proper functioning of commodity spot exchanges. Banks and exchanges should work together towards amending this type of regulation and further allow financial institutions to take part in commodity spot trade.
• Exchange regulators have to be able to cope with an active commodity exchange (whose trade could quickly grow to a volume larger than that of the country’s financial markets). Therefore, they should anticipate further growth of the exchange well in advance and hence design the regulatory framework accordingly in advance.
• Not only does the exchange trading system need to be sound, it also needs a strong clearing system to provide security to those using the exchange, which requires good cooperation with the banking system as well.
• Regulations should strengthen a proper delivery system normally using warehouses
• The leading financial institutions as well as the leading commodity market players should unite their efforts to establish a well-functioning and reliable clearing system to guarantee commodity trade at the exchange.

Let us now look at few successful spot markets around the world. The exchanges covered are:

1. Ethiopian Commodity Exchange
2. Shanghai Gold Exchange
3. Izmir Mercantile Exchange
4. Belarusian Universal Commodity exchange
5. Sofia Commodity Exchange
6. Natural Gas Spot Trading - Mexico
7. Electricity Spot Trading - USA
8. Eurasian Trade System Commodity Exchange
9. Dubai Mercantile Exchange
10. Dubai Gold and Commodity Exchange
11. Iran Mercantile Exchange

Ethiopia Commodity Exchange

The Ethiopia Commodity Exchange (ECX) is a spot exchange established in Addis Ababa, Ethiopia. More than 200 different spot contracts are traded by the ECX members or their authorized representatives through open outcry trading system.

ECX offers an integrated warehouse system from the receipt of commodities on the basis of industry accepted grades and standards for each traded commodity by type to the ultimate delivery.