A seminar on trading coffee on the London International Financial Futures and Options Exchange (LIFFE) was recently held to evaluate the results of one year of participation.
Mr. Van Thanh Huy, Chairman of the Vietnam Coffee Association (Vicofa) and Director of Dak Lak Import-Export Investment Company (Inexim Dak Lak), shared his insights about this relatively new activity for Vietnamese coffee businesses.
One Year of Trading on LIFFE
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Q: Could you share the results of one year of futures contract trading on LIFFE for Inexim Dak Lak and other coffee businesses?
Mr. Van Thanh Huy: From having only one participant—Inexim Dak Lak—there are now 33 Vietnamese companies trading on LIFFE through Techcombank, including 11 state-owned and 22 private enterprises.
These companies are mainly located in Dak Lak, Gia Lai, Binh Duong, Ho Chi Minh City, and Hanoi. About 40% are direct import-export companies, while the rest are coffee collection and processing agents.
So far, the total trading volume has reached over 70,000 lots (each lot equals 5 tons of green coffee), or about 350,000 tons of coffee.
According to Techcombank, futures contracts have been effectively used as a hedging tool and to determine real market prices. During the sharp price fluctuations in February, June, and July 2005, these contracts helped businesses reduce the risk of sudden price spikes and also brought benefits to coffee farmers.
Risk Management in Futures Trading
Q: Some domestic businesses worry that trading on LIFFE carries high risks. Could you explain the technical aspects of using futures contracts to hedge against price risks?
Many companies join LIFFE not for hedging but for speculation—buying when prices are expected to rise and selling when they expect prices to fall—thus taking on greater risk. Their forecasts may not match those of large speculators, who have significant influence over the market.
In contrast, when trading physical coffee, combining it with futures or options contracts on LIFFE can bring moderate profits and reduce risk.
Simply put, to ensure that their domestic coffee business does not suffer losses in a volatile market, traders can buy or sell coffee futures online, placing a sell order as soon as prices are profitable.
Example:
A company signs a contract to sell 500 tons of coffee at USD 900/ton for delivery in January 2006, but fears that prices might rise. To hedge, the company buys 500 tons of coffee futures at the same price.
By the time of delivery, if prices rise to USD 950/ton, the company loses USD 50/ton on the physical coffee market but gains USD 50/ton from selling on the futures market—effectively offsetting the loss.
Benefits for Coffee Farmers
Q: While companies can profit or at least reduce losses, how do coffee farmers benefit?
In the past, when export prices rose, companies would buy coffee from farmers at higher prices. But when export prices fell, they would force prices down for farmers.
With futures contracts, companies are willing to pay farmers higher prices than the domestic market rate if they can profit from selling on the futures market.
Example:
If the export contract price is USD 915/ton, equivalent to buying from farmers at 14,000 VND/kg, the company makes a profit.
At the same time, if the London price rises to USD 1,095/ton, the FOB price is about USD 1,005/ton (USD 90/ton lower than London), allowing companies to raise their purchase price for farmers to 15,400 VND/kg.
Clearly, if companies time their futures trades well, they can pay farmers higher prices.
Legal Framework and Government Policy
Q: Some state-owned companies worry about legal risks if they incur losses while the government has not officially approved commodity exchange trading. Has this concern been addressed by the 2005 Commercial Law?
The Commercial Law, passed in June 2005, permits “trading goods through commodity exchanges,” including futures and options contracts.
According to the law: “Vietnamese traders have the right to trade goods through foreign commodity exchanges as regulated by the government.” A government decree on trading through commodity exchanges will be issued.
This provides a legal framework for Vietnamese companies to confidently participate in LIFFE. Vicofa has also recommended that the state clearly define this framework and enact it into law to facilitate trading for companies and brokers.
Advice for New Participants
Q: With your one year of experience in the futures market, what advice would you give to companies wishing to participate in LIFFE?
Companies using futures contracts should view them primarily as a risk management tool, not as a way to seek large profits. The higher the profit target, the greater the potential risk.
In addition, companies must carefully balance their financial capacity when trading on LIFFE.
They also need to maintain:
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a coffee storage system,
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a collection network,
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a market research and technical analysis department, and
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a global and domestic price forecasting strategy,
along with good management and quick decision-making in all situations.