VFEX derivatives . . . New era for tobacco
THE Victoria Falls Stock Exchange (VFEX) may soon launch a derivatives market for tobacco, following an agreement with parent firm, Zimbabwe Stock Exchange (ZSE) and the Tobacco Industry and Marketing Board (TIMB), which could unlock significant funding for the golden leaf producers.
The agreement, which saw the parties ink a memorandum of understanding (MoU), would also open funding avenues for tobacco merchants while the derivatives market could ensure farmers get paid for their crop on the “futures market” well before they deliver the crop.
A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset (like a security) or set of assets (like an index). Common underlying instruments include bonds, commodities, currencies, interest rates, market indexes, and stocks.
The contracts, based on tobacco derivatives, would result in tradable securities, which the holder at any given moment would be able to use as collateral, including for purposes of securing loans from the banks and or other lenders.
The ZSE, VFEX and TIMB have since signed a Memorandum of Understanding (MoU), which they say was prompted by challenges of funding and marketing faced by small scale tobacco farmers and tobacco merchants as well as limited hedging instruments in terms of prices and risks.
As such, the partnership will fundraise for farmers and merchants, establish a derivatives market for local tobacco on the VFEX, while it would also entail compilation and distribution of data on tobacco production and marketing.
Tobacco is Zimbabwe’s second biggest foreign currency earners after gold. The sector now employs hundreds of thousands of indigenous blacks. Prior to the land reform programme, about 2000 large scale commercial farmers produced 200 million kgs, an average of 200 tonnes per farmer.
Zimbabwe is one of the largest producers of tobacco in Africa, exporting US$782 million in the 2020 season. But while tobacco is making some people rich, the farmers sucked into contract farming at the bottom of the pile are losing money.
TIMB acting chief executive Meanwell Gudu said the latest arrangement would see the partners approaching investors on VEFX, who have deep US dollar pockets, for funding required by farmers in order to optimally produce tobacco, a major export earner for Zimbabwe.
“We have got investors who might want to say if I give you money, my return is so much after a year; the coupon rate is so much after a year or so. We believe that even for farmers, it might be better because the cost of borrowing on the VFEX might be lower than the cost of borrowing directly,” he said.
Gudu said the initiatives were in sync with the Government’s thrust of making sure the bulk of tobacco grown in Zimbabwe is funded with local
resources to optimise the foreign exchange returns from exporting the lucrative crop.
Under the current tobacco financing model, the vast majority of tobacco farmers receive inputs and support services from merchants who are funded by offshore investors, a scenario that sees most of the money after the tobacco is sold going to the offshore funders.
Gudu said the regulatory authorities, especially TIMB and the Reserve Bank of Zimbabwe (RBZ), had all the records on farmers with solid production and delivery records whom they would identify and support with requisite funding in order to produce. Farmers would be carefully selected to prevent high defaults on funded contracts through side marketing of contracted “leaf gold” by farmers, which has previously seen merchants losing their money after investing in tobacco production.
Gudu said the arrangement on financing for growers could improve viability of farmers, who currently have to contend with high costs of production and huge capital outlays required to produce. On average the industry needs US$350 million per season.
But in what reflects innovative thinking in funding tobacco growing, Gudu said the VFEX would establish a derivatives market, a kind of futures market, which would see investors agreeing to pay farmers for future tobacco deliveries. This comes after VFEX recently signed an MoU with the Dubai Gold and Commodities Exchange (DGCX), the Middle East’s leading derivatives exchange, to strengthen bilateral cooperation as well as exchange knowledge around commodities trading.
“(Essentially derivatives are) a futures market. I will give you an example; if someone is growing 100 hectares of tobacco, and you know the yield is 200 000 kg, as an example, we might have a buyer saying if your total production is 200 000kg and average price is say US$3/kg so if you multiply, that will be US$600 000.
“If it is a futures market, the buyer may be from Dubai or anywhere else might say can I give you US$500 000, and then the concept of present and future value of money comes in. If a farmer can get US$500 000 now it is better off than getting US$600 000 probably after 18 months,” he said.
He said a single investor could enter into an arrangement with several farmers, a futures market, and pay for the tobacco crop in advance while the farmers would have to deliver the crop in future, but benefitting from present value of money.
Gudu said they had been given assurance by ZSE and VFEX that while there only was a handful of listings at the moment, more entities or investors had indicated strong interest to list on the board, chief foreign investors and domestic mining firms.