A future without fear

Using financial instruments to hedge risk

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Farming is a proverbially uncertain business, with nature an unpredictable quantity that is sometimes friend, sometimes foe. However, although nobody can predict the future, with experience and the assistance of a financial partner with insight into agriculture, it is possible to hedge against risk. We spoke to Dr Raphael N. Karuaihe, Head: Commodities at JSE Capital Markets, to find out more.

From a JSE perspective, what are the major challenges faced by small farmers in securing finance?

The challenges are numerous for smallholder farmers. Lack of credit history, lack of financial guarantees, lack of storage, inconsistent farming practices, poor yields and so on, are but some of the challenges.

How can small farmers use the JSE certificate as an instrument to use as collateral at commercial banks?

When delivering their maize at commercial storage facility registered as a JSE delivery point, farmers can request a JSE silo certificate. The certificate will indicate the type of grain, tonnage and quality of the commodity stored in the name of the farmer. The farmer can then cede this certificate to the bank in exchange for funding.

How can farmers gain such a certificate in the first place?

Farmers need to deliver their grain at a JSE-approved storage facility and request that a JSE certificate be issued. A list of approved storage operators and their locations is available on the JSE website.

What commodities can farmers trade through the JSE?

White and yellow maize, wheat, soybeans, sunflower seeds and sorghum are the principal commodities.

How can farmers benefit from the JSE agricultural derivatives market?

The JSE agricultural derivatives market is a platform where participants can manage price risk and discover the market price (fair value) of the commodity being traded. An added benefit is that all the transactions are guaranteed by the JSE and there won’t be any counterparty risk for the farmer.

How does price hedging work, and how does it benefit small farmers?

Hedging only applies to those market participants who have a vested interest in the traded commodity. Typically, farmers who produce and millers who process the commodity can be classified as hedgers when they sell (farmers) or buy (millers) contracts on the exchange to “lock in” a favourable price and avoid being exposed to rising and falling prices. The transaction the farmer enters into today will be for delivery at a stipulated future date.

What support does the JSE provide in terms of deciding when to hedge?

The JSE only provides an enabling environment and an efficient market for participants to trade and discover market prices. However we leave the trading decisions and advice to the brokers (commodity members).

What is the full range of JSE financial instruments related to agriculture?

We offer futures and options and a combination of both.

What does the JSE consider in producing a new agriculture-based financial instrument?

The financial instruments themselves are standard globally. However, when it comes to introducing new agricultural products, we normally consult the market to gauge the appetite. Sometimes we introduce products upon request from market participants.

When it comes to selling an agricultural derivative, is it possible to sell at any time?

Certainly. Mostly in consultation with his broker, a farmer can lock in a price three, six or even nine months in advance if he feels it is the right thing to do.

How is the value of the derivative determined?

The JSE uses a methodology called marking to the market on a daily basis to determine where the various instruments a closing the trading session. Simply put, this is a weighted average of all qualifying trades taking place in the last five minutes before the market closes.

Could JSE financial instruments be a way to get around the problem faced by farmers on communal land unable to use title as collateral?

Yes, certainly. The only challenge sometimes is that the communal farmer does not produce enough to have critical mass. Therefore it may be ideal to take positions on the JSE as a group or cooperative to benefit from economies of scale. There are some agribusinesses dedicated to helping emerging farmers in this regard.

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