By Julie Lerner, Founder & CEO, PanXchange.  Article originally published in Cornerstone Journal of Sustainable Finance & Banking, June 2015.

Author’s note:

On the heels of a successful pilot, August will mark my third trip to Kenya and the live launch of PanXchange’s web-based software. Our platform facilitates the negotiation of East African grains between farmers and commercial buyers. I am not an expert on East African politics, nor on the specific challenges of the smallholder farmer. The following, however, is based on my commodity market knowledge, experiences both as a founder of a start-up and angel investor, as well as extensive research on building liquidity.

Three things we know about Africa

1) Improving agrarian economies dramatically reduces poverty and improves a nation’s overall economic strength; 2) East Africa is the hottest place on the globe for agriculture based profit opportunities; and 3) As we watch the South African Exchange (JSE/SAFEX) continue to flourish, the political interest in replicating a successful futures and derivatives exchange is at an all-time high.

Yet according to a recent Bloomberg article, the Ethiopian Commodity Exchange (ECX) “is one of at least eight commodity exchanges started in sub- Saharan Africa over the past two decades with the aim of improving food security for local  populations. Many have failed, and only South Africa’s is thriving without government support.”

The article continues, “Trading floors have flopped in Zambia, Uganda, Nigeria, Zimbabwe, and Kenya. Each one, analysts say, suffered from the same flaw: a top-down approach that’s better at attracting foreign aid than at improving farming practices and developing transportation and communications networks.”

I concur with the conclusion, yet I think it’s missing one other critical component. Specifically, does a national exchange make good business sense? If an exchange needs government support (and likely international aid funding) to keep it alive, does it provide any benefit to the nation’s economy and the well being of its populace?

South Africa’s Success

There is no doubt that the JSE/SAFEX exchange is the continent’s biggest commodity success story. It was launched in 1996, midway through the post-apartheid decade, just when the government deregulated the market. According to a 2009 UNCTAD study (PDF), South Africa also had these attributes:

  • High level of trust and cooperation amongst industry;
  • Government commitment to respect the pricing mechanism;
  • A broad-based approach to market development, incorporating futures, spot and financing instruments;
  • Strong existing warehouse and logistics infrastructure;
  • Development of a robust delivery mechanism integrated with financing solutions;
  • Emphasis on education.

Yet East and West Africa don’t have most of these drivers. Without them, unfortunately, attempts to synthetically replicate the JSE don’t make good business sense. It is too much to build given the lack of infrastructure in nations to the north. What’s missing is the focus on 1) what it takes to connect smallholder farmers to the market, and 2) growth strategies that are realistically attainable and financially sound. Look again at the six drivers above. Each one is essential to building a strong foundation — and each is a massive undertaking on its own.

Keys to Success in a Developing Nation

The first task is to flip the equation from a top-down political approach to one that’s bottom-up. Similarly, we need to break down the far-reaching goals of international aid, then look at a commodity exchanges from a business perspective:

Who is your customer and what problem are you trying to solve? Addressing the needs of the smallholder and how to get their crops to market has a completely different set of issues than a national exchange that needs a critical mass for liquidity.

Are your goals reasonable? These entities are attempting to build an entire supply chain, yet they could and should be broken down in at least two or three different stages. You can’t have a robust derivatives market if the underlying physical market is broken.Are your numbers sound? Reasonable fees for your target market? How many users are needed to reach the break-even point? What is the addressable market for the derivatives? Is it enough for liquidity and to break even? I assume this question is the toughest to address from a top-down approach, as these nations simply do not have enough players for a financially sustainable exchange.

Conclusion

No one wins if we swing for the fences. International aid should focus on empowering smallholders through education and helping organize the cooperative buying of inputs and marketing postproduction. Governments should focus on agricultural infrastructure — both the physical infrastructure (roads, ports, etc.) but also market structure – so that an efficient procedure will make contracts more enforceable for freer movement of goods, including support of standardized contract
terms and quality specifications.

If we focus on building a strong foundation, we can empower the smallholders and improve the agrarian economy. Once we get to that point, perhaps a national exchange will become economically viable.