Agro derivatives markets

Published on February 8, 2021 by Entrima

In the ‘agro’ markets, physical players come together to enter into supply contracts. This concerns parties with a physical need or desire, including producers and consumers. Next to supply contracts, market participants enter into derivatives contracts. These instruments can be applied by physical players to hedge their price exposures, or, alternatively, by financial players, to create an exposure. The latter could be performed by investors and other parties with a financial interest or objective.

Contracts concerning agricultural commodities can be transacted bilaterally, in the over-the-counter (OTC) markets. Alternatively, ‘agro’ contracts are traded on an exchange, via a trading platform operated by the trading venue. In case of an over-the-counter transaction, with settlement in time, both counterparties are exposed to counterparty risk. The buyer faces delivery risk, whereas the seller faces credit risk. In case of exchange-trading this does not apply. Deals concluded on an exchange are cleared by the ‘central counterparty’ (CCP), also called the ‘clearing house’. This implies the clearing house takes over counterparty risk. As a result, the clearing organisation requires parties with an open exposure to pledge cash collateral, or margin, as a temporarily deposit. In case of a failure, this ‘margin’ serves to cover potential losses for the clearer.

Brokers facilitate trading in the OTC ‘agro’ markets. In order to trade on an agricultural commodity futures exchange, a market participant requires a membership. Alternatively, to transact on exchange, one could do so via the membership of another party, possibly a brokerage firm.

Transactions take place at a certain price and for a particular volume. Globally, in the wholesale markets for agricultural products, typically, pricing takes place in US dollar. Prices are quoted in different units of trading. Soybeans can be priced in dollars per tonnes. However, soybean futures contracts are quoted in cents per bushel. Besides, bean oil futures contracts are quoted in cents per pound, and soymeal contracts are quoted in dollars per short tonne.

 

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