management did not believe prices would fall, so why pay money for option premiums? CRDB, however, has made the provision of price risk management a part of its operations, and at least one other coffee cooperative has recently followed KNCU’s example.
In the 1990s, the feeling among many in the international development community was that cooperatives would have to play a critical role in intermediating between farmers and risk management markets. To a certain extent, this was understandable—after all, most individual farmers produce too little for efficient risk management, and some form of aggregation is necessary. However, as a first lesson from experience, this view in practice has proven not very helpful, for two reasons. Firstly, the large majority of developing country’s farmers— and this is no different for coffee farmers—are not organized in efficient and effective cooperatives. Secondly, even well-organized cooperatives often have internal dynamics (e.g., managers are elected and rotate regularly; decision-making is bureaucratic) which prevent proper use of risk management markets.
Experience has shown that while farmers’ associations can play an important role, the critical factor lies in the interface between such associations (formal ones like cooperatives, and informal ones like marketing groups) on the one hand, and an outside agency (likely to be a bank, possibly a government agency). The dynamics between the two can drive the adoption of a risk management strategy, and make it sustainable.
A second lesson is that KYC rules now are such that for all means and purposes, direct access to developed country futures exchanges by farmers’ associations in developing countries is virtually impossible. Farmers will need either local exchanges, or local aggregators who have the commercial size and savvy to open trading accounts with brokers or banks in the developed world.
A third lesson is that there are many benefits of combining risk management and finance. Financiers can act as a gateway to risk management (in particular as they already have the necessary relationships with the international financial community), and provide the necessary funding for paying option premiums or even covering margin calls. From the financier’s perspective, this reduces credit risk and adds a useful new revenue stream.
A fourth lesson is that there is no “one size fits all” risk management solution. Even within a group, farmers like to be given an array of solutions from which to choose. Risk perceptions and the willingness to pay, or give up a part of future upside potential, for managing risks is different from farmer to farmer. Schemes that work well are those that provide such choice.
Finally, experience has shown one important positive lesson: the concept of market-based risk management instruments such as futures, options and their derived over-the-counter products is not difficult to grasp for most farmers. In fact, they will readily understand these instruments well enough to make opportunistic choices about their use. As farmers tend to be optimistic—farmers anywhere in the world tend to systematically underestimate risks— this implies, for example, that they are more likely to want to lock in future prices at times of high prices; while if prices are low, they consider it likely that prices will increase so and see no need to cover the downside risk. So, after a knowledgeable cooperative has one year done a successful risk management strategy, it may not wish to repeat the experience the next year. In other words, risk management providers should not expect a stable client base.