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  • QA 119
    Question:
    What would be the pre-requisites for establishing a futures market in Vietnam?
    Background:
    In order to build a sucessful futures market in Vietnam, what are the conditions to be considered?
    Asked by:
    Exporter - Vietnam
     
    Answer:

    Broadly speaking, to support a futures market a cash market must have certain characteristics: sufficient price volatility and continuous price risk exposure at all levels of the marketing chain; enough market participants with competing price goals; and a quantifiable underlying base commodity that can be standardized. 

    In the coffee cash market participants buy and sell specific parcels of physical, green coffee of varying quality that will be delivered immediately or promptly. In the coffee futures market participants buy and sell a price for a standard quality of coffee, for delivery in the future. The mechanics and functions of futures markets are clearly described in Chapter 8 of the Guide - our answer therefore goes straight to your particular situation.

    We do not know if Vietnam's physical production, and therefore its cash market, is large enough to sustain an independent futures exchange - it may well be. To note though that, to date, the only producing country to establish a successful coffee futures market is Brazil - go to www.bmf.com.br. India has made valiant efforts to establish an exchange trading both arabica and robusta but has so far failed to generate the necessary liquidity. In this respect one should note that Brazil's success is arabica based - its robusta contract also lacks liquidity. This may be due to the fact that most Brazilian robusta is in fact consumed domestically.

    The Brazilian exchange in Sao Paulo reflects the internal market of Brazilian arabica in dollars while the export market is always priced as a differential to the New York C contract. When Brazilian exporters sell forward export shipments they will buy futures at the Sao Paulo market as a hedge until the physical coffee becomes available. They are confident that the internal, the local physical market will always be reflected in the Sao Paulo market whereas doing arbitrage between Sao Paulo and New York ensures the differential is safe. See QA 098 for more on this. *

    We would suggest that any Vietnamese exchange would have to offer similar linkage to the London robusta market - if not it would be a purely local affair that might not attract the necessary liquidity. 

    Given the size of recent harvests and the tendency of many Vietnamese growers and traders to take market views, we could imagine that the number of potential participants, growers, traders, processors and exporters might be large enough to provide substantial liquidity. However, as the failed Singapore coffee futures experience of some years back has shown: without the presence also of outside interests, including speculators who take an opposite market view, futures markets cannot function…

    Again, Chapter 8 gives a clear overview of the regulatory framework and physical infrastructure necessary to enable a futures market to function. Chapter 9 explains how the coffee industry and others use futures markets and both make it obvious that establishing a new futures exchange will be both time-consuming and costly.

    For the Vietnamese industry to contemplate establishing an exchange would in our view first of all require looking into the following: 

    • Can coffee quality be sufficiently standardised to enable a futures contract specification (quality, delivery points etc) to be drawn up?
    • Could a local exchange operate in US currency so as to provide the necessary linkage between it and the London robusta market (that is also quoted in dollars)?
    • Does the regulatory environment (legal, financial, taxation) encourage free participation by potential participants, both local and foreign?
    • Who would provide the financial infrastructure (Clearing House etc) without which no futures market can function?

    Finding positive answers to these questions in our view constitutes a necessary first step towards undertaking any wider assessment, consultation with for example the Sao Paulo and London exchanges, etc.

    * Many growers also use the Brazilian exchange's spot contract. - all contracts are for 100 bags each and therefore readily accessible also for smaller growers.

    Posted 19 October 2006

     

    Related chapter(s):
    Related Q & A:
    QA 016, 040, 042, 051, 054, 098