Page 233 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes of Addis Ababa, where the auction would be held. The coffee would be grown in different
locations in the country and traded in a central market. When the coffee would arrive, the
truck carrying coffee would be identified and tagged by the local authority in the producing
areas. The truck would be sealed and a voucher representing the details would be issued.
The trucks would be mandated to take the coffee only to the auction centre. At the auction
centre, the grading unit would draw the samples and grade would be assigned. The coffee
would not be offloaded and would remain on the truck. This means that the owner of the
coffee has to pay the rent for the truck as long as it remains parked in the compound of the
auction centre.
After the grade was assigned, the sample would be made available to the buyer to inspect.
The auction would be carried out in a room called as auction centre, where the samples
would be displayed. The buyers would bid for each lot and the highest bidder would win
the bid.

However, the system was not so simple. The buyers were few and suspected to have
cartels. These buyers would meet and fix up the maximum price to be offered to the
sellers. Also an unsaid understanding would exist where, a specific seller would be offered
price by a specific buyer only. It was like saying “I don’t bid for your supplier and you
don’t bid for mine”. Also, as this was a two-way arrangement, the sellers also would like
to have a secretive understanding with buyers for supplies and prices.
During the bidding, the buyers would offer a price and accepted by the seller. This would
be noted by the auction authority and the buyer would be asked to deposit the cheque
against the proposed purchase. Now the seller would have the responsibility to deliver
the coffee at the buyers’ warehouse. When this happened, the seller would be paid after he
produced the delivery completion document.

The major dispute and exploitation of the seller used to happen here. The buyer would
disagree upon the quality or quantity and did not accept the delivery. The seller, faced
with a difficult choice to make, would accept discount to be adjusted in cash, and deliver
the coffee. Sellers would always be price takers.

The market failure evident in this case is mainly the monopoly; where the bunch of buyers
would dominate the market and not allow the sellers on equal footing. Second was the
information asymmetry. The buyers could afford to subscribe to news resources like
Reuters and keep updated information about the international prices. But the sellers would
not know it.
Government intervention in this case was called for and the government intervened by
revamping the legal framework. All coffee produced in Ethiopia was mandated to be
traded only at the recently established commodity exchange. The Ethiopia Commodity
Exchange or the ECX, through the law passed for coffee trading in Ethiopia, became the
single designated market place for coffee. The enactment was received with lot of
opposition, but the strong will of the government to enforce the same made it effective.

The mandatory trade of coffee through the ECX ensured that the buyers and the seller
were on equal footing. The exchange’s system ensured that the delivery point is the
exchange warehouse and the guarantee for the quality of the goods is advanced by the
exchange. This also was supported by the policy of the exchange to execute the trades
based of warehoused goods, which could be sold within 30 days against the on truck sale
earlier. The concept on non-identity preserved warehouse management system meant
that the deposits lost the identity and the malpractice of secretive agreements between
buyer and sellers were broken. Further, information dissemination by the exchange ensured
that the market failures are removed.
Contd....

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