93923 AGRICULTURE GLOBAL PRACTICE DISCUSSION PAPER 02 RISK AND FINANCE IN THE COFFEE SECTOR A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector WORLD BANK GROUP REPORT NUMBER 93923-GLB FEBRUARY 2015 INTERNATIONAL COFFEE ORGANIZATION AGRICULTURE GLOBAL PRACTICE DISCUSSION PAPER 02 RISK AND FINANCE IN THE COFFEE SECTOR A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector INTERNATIONAL COFFEE ORGANIZATION © 2015 World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org Email: feedback@worldbank.org All rights reserved This volume is a product of the staff of the World Bank Group. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of World Bank Group or the governments they represent. 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CONTENTS Acknowledgments vii List of Acronyms ix Executive Summary xi Chapter One: Taming Risk and Unlocking Finance for a Vibrant Coffee Sector 1 Unrealized Potential: The Costs and Financing Implications of Unmanaged Risk 2 Access to Credit and the Ability to Manage Risk Effectively is Not Equal 2 The Greatest Potential for Improvement in Risk and Finance Exists at Origin 3 The Use of Case Studies to Illustrate Improvements in Risk and Finance 3 Chapter Two: Risk in the Coffee Sector 5 The Major Risks and Constraints in Coffee Production and Trade 6 Chapter Three: Finance and the Coffee Supply Chain 9 Availability of Finance 10 Constraints in Accessing Finance 11 Chapter Four: The Dynamics of Risk and Finance 13 Chapter Five: Case Studies 15 Enabling Environment 15 Market Risk 15 Production Risk 15 Improving Bankability for Coffee Sector Borrowers 15 Aggregation: the Challenges and Opportunities to Increase Finance 16 Value Chain Approaches to Risk Management and Finance 16 Case Study 1: The Importance of a Supportive Enabling Sector Environment: Uganda, Tanzania, and Kenya—A Comparative Case Study 16 Case Study 2: The Value of Regional Private/Public Sector Initiatives: The Example of the African Fine Coffees Association 21 Case Study 3: Futures Markets in Coffee-Producing Countries 25 Case Study 4: Implementing Price Risk Management in the Rwandese MarketPlace 31 Case Study 5: Minimizing Price Risk through Variable Sales Using Call Options 34 Case Study 6: The 2012 Latin American Coffee Rust Outbreak: “Black Swan” or “New Normal”? 38 Case Study 7: Recent Experiences of Coffee Replanting Programs in Colombia 43 Case Study 8: Utilizing Technology and “Boots on the Ground” to Reach New Customers in India: The Sub-K Approach 51 Case Study 9: Farmers’ Access to Credit through the Use of Credit Guarantee Services: Experience of Coffee Farmers in Ethiopia and Rwanda 53 Case Study 10: Incorporating Price Risk Management Into the Lending Operations of a Tanzanian Bank: 2005–07 57 Case Study 11: Cédula de Produto Rural: A Tradable Receipt in Brazil 60 Case Study 12: COMRURAL Honduras—Crowding in Commercial Banks through Matching Grants 66 Case Study 13: De-risking the “Missing Middle”—The Case of Root Capital, a Socially-Oriented Lending Institution 70 Case Study 14: Warehouse Receipt Systems in the Coffee Sector: African Experiences 76 Case Study 15: The Benefits of Modernizing Costa Rican Coffee Cooperative COOPETARRAZU 79 Case Study 16: Nsangi Coffee Farmers Association, Uganda 85 A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector iii Case Study 17: Strengthening the Financial Capacity of Smallholder Businesses: The PorFin Project 88 Case Study 18: Facilitating Lending to Smallholder Producer Groups—The Twin Approach 94 Case Study 19: Evolving Supply Chain Management: An Example From China 101 Case Study 20: Extending Access to Finance through the Use of Supply Chains 105 References 109 Summary of Case Studies Contained within Report 113 BOXES Box 5.1: Livelihood Triad 51 Box 5.2: Interviewing Farmers on Coffee Financing 65 Box 5.3: Musasa (Rwanda): Enabling Investment in Infrastructure and Equipment 74 Box 5.4: COOMPROCOM (Nicaragua): Supporting Cooperative Microloan Programs 75 Box 5.5: UNICAFEC (Peru): Long-Term Loans for Coffee Renovation 75 Box 5.6: High Level Profile of Olam 105 FIGURES Figure 1.1: Interrelationship between Risk and Access to Finance 3 Figure 2.1: The Three Principal Types of Agricultural Risk 6 Figure 3.1: Availability of Finance 11 Figure 5.1: Availability of Finance 16 Figure 5.2: BM&F Arabica Futures Turnover 26 Figure 5.3: Turnover (in MTs)—Coffee Futures Exchange India 27 Figure 5.4: Three Seasons and the Relationship between Price and Fairtrade Minimum Price 37 Figure 5.5: Proportional Production Changes by Country 39 Figure 5.6: Fieldbook Data from Coffee and Climate Initiative Project Farms in the Trifinio Zone 42 Figure 5.7: Increase in Tropical Storms and Hurricanes since 1990 43 Figure 5.8: Worried Well: Studies on How Coffee Affects Consumers’ Cancer Rates Have Trumped Supply Problems Like Rust 43 Figure 5.9: Colombian Coffee Production (million bags) 44 Figure 5.10: Coffee Productivity (60 kg bags/ha) 44 Figure 5.11: Productivity as a Function of Crop Density 45 Figure 5.12: Productivity as a Function of Plantation Age 45 Figure 5.13: Renewed Area under the Competitiveness Program (’000 MT) 46 Figure 5.14: PSF Main Achievements: Investments, Covered Area, and Producer Beneficiaries 49 Figure 5.15: Renewed Area Competitiveness and PSF (’000 Ha) 49 Figure 5.16: Total Area Renewed (2006–11) 49 Figure 5.17: Total Planted Area and Share (%) by Variety 50 Figure 5.18: Average Plantation Age and Average Plantation Density 51 Figure 5.19: Agricultural Exports Percentage of Total 2002 61 iv Risk and Finance in the Coffee Sector Figure 5.20: Agricultural Exports Percentage of Total 2012 61 Figure 5.21: Export of Coffee in Brazil in US$ Billions (Constant Prices, 2013) 61 Figure 5.22: Total Rural Credit Supplied by the National Rural Credit System 62 Figure 5.23: Financial CPR registered by CETIP—2004–13—BRL Millions (Constant Prices of 2013) 64 Figure 5.24: Financial CPRs registered on CETIP—2013 64 Figure 5.25: Average Portfolio Balance in Coffee by Year—2008–13 71 Figure 5.26: Portfolio, Coffee and Non-Coffee—2002–13 72 Figure 5.27: Root Capital’s Value Chain Finance Model 73 Figure 5.28: 2011/2012 Season 81 Figure 5.29: 2012/2013 Season 82 Figure 5.30: 2013/2014 Season 82 Figure 5.31: Pre- and Post-positions of Cooperatives against Targets 91 Figure 5.32: Twin Trading Volumes 1991–13 (metric tons) 95 Figure 5.33: Triangular Model of Trade Finance 97 Figure 5.34: China Coffee Development 2000–13 (MTs pa) 102 Figure 5.35: OLAM’s Supply Chain/Value Chain Approach 106 TABLES Table 3.1: Supply Chain Activities and Financing Sources and Requirements 10 Table 5.1: Coffee Industry Characteristics of Kenya, Tanzania, and Uganda 20 Table 5.2: Seasonal Price Volatility 34 Table 5.3: Outcome from Call Options Utilized by Nicaraguan Cooperative 2013/14 Season 36 Table 5.4: Credit Lines and Programs of Incentives for Coffee Growers, 2011 47 Table 5.5: Performance of COOPETARRAZU and Price Volatility Experienced during Seasons 2011–14 79 Table 5.6: Key Aspects of Cooperative Performance 2008–12 87 A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector v ACKNOWLEDGMENTS This study is the outcome of a collaborative approach between the International Coffee Organization (ICO) and the World Bank’s Agricultural Risk Management Team. The concept of this report emerged during the September 2012 meeting of the Core Group of the ICO’s Consultative Forum on Coffee Sector Finance. Its objective is to raise awareness of risks and their impacts on different actors at different stages of the value chain; illustrate potential means for managing risks through the implementation of a variety of programs and mechanisms; and demonstrate a series of innovations where attempts have been made to improve access to finance. The direct correlation between improved risk management and improved access to finance is challenging to show con- clusively; however, anecdotal evidence suggests that improvements in the management in risk can often lead to improvement in finance and vice versa. To meet these goals, this report brings together interesting and relevant case studies from coffee-producing coun- tries showcasing risk, risk management, and improved access to finance. The authors of this report would like to thank all of the ICO members and coffee sector participants who contributed information, data, and, especially, case studies to this report. This report was prepared by a team led by Roy Parizat, Senior Economist at the World Bank, and comprising Jan van Hilten (Consultant, Coffee Specialist), Erin Tressler (Consultant, Risk Management Specialist), Michael Wheeler (Consultant, Coffee Specialist), Robert Nsibirwa (Consultant, Coffee Specialist), Rebecca Morahan (Consultant, Coffee and Risk Management Specialist), Manel Modelo (Consultant, Coffee Specialist), Humberto Spolado (Risk Management Specialist), Jan De Smet (Consultant, Coffee Extension and Production Specialist), and David Pinto (Consult- ant). Damian Milverton served as External Consulting Editor to the final document. A wide range of people and organizations involved in the coffee sector very generously contributed case studies and associated information, including: Denis Seudieu (ICO), the African Fine Coffee Association (AFCA), Paul Stewart (Technoserve), Sustainable Harvest Coffee Importers, Peter Baker (CABI), Luz Diaz (World Bank), Reji Varghese (BASIX India), CRDB Bank Tanzania, Elizabeth Teague (Root Capital), the Board and Managing Director of COOPERTARRAZU, Nsangi Coffee Farmers Associa- tion, Rabobank Foundation, Progresso, and Twin Trading, London. The Coffee Guide, a website and resource provided by the International Trade Centre1, also shared a great deal of helpful information. The World Bank and the Multi-Donor Trust Fund, supported by the Netherlands Ministry of Foreign Affairs and the Swiss Secretariat for Economic Cooperation, con- tributed the finance for this initiative. 1 http://www.thecoffeeguide.org/. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector vii LIST OF ACRONYMS 4C Common Code for the Coffee FNC National Coffee Fund/Federation Community of Coffee Producers/Colombian ACE Agricultural Commodity Exchange Coffee Growers Federation ACRAM African and Malagasy Robusta FNI Financiera Nicaraguense de Coffee Agency Inversiones AFCA African Fine Coffee Association FOMIN Multilateral Investment Fund BCEC Buon Ma Thuot Coffee Exchange Funcafe Fundo de Defesa da Economia Center Cafeeira BID/FOMIN Fondo Multilateral de Inversiones GBE Green bean equivalent del Banco Interamericano de GDP Gross domestic product Desarrollo IAT Technical assistance incentive BM&F Bolsa de Valores, Mercadorias & ICAFE Costa Rican Coffee Institute Futuros de São Paulo ICE InterContinental Exchange BOI Bank of India ICO International Coffee Organization BPR Banque Populaire du Rwanda IADB Inter-American Development BRL Brazilian Real (Currency) Bank CABI Centre for Agriculture and IFC International Finance Corporation Biosciences International ITC International Trade Centre CBO Cooperative Bank of Oromia LBAs Licensed buying agents Cenicafé National Center for Coffee Research LIFFE London International Financial CFC Common Fund for Commodities Futures and Options Exchange CLAC Coordinadora Latinoamericana y del MFIs Microfinance institutions Caribe de Pequeños Productores MT Metric ton de Comercio Justo NaCORI National Coffee Research Institute CLR Coffee leaf rust; la roya NAS Nestlé Agricultural Services COFEI Coffee Futures Exchange of India NCDEX National Commodity and Derivative COMRURAL Rural Competitiveness Project Exchange COOMPROCOM Cooperativa Multisectorial Productores NCMSL National Collateral Services Ltd. de Café Orgánico de Matagalpa NMCE National Multi-Commodity COOPETARRAZU Cooperativa de Caficultores y Exchange Servicios Múltiples de Tarrazú NREGA National Rural Employment CP Competitiveness program Guarantee Act CPR Cédula de Produto Rural NUCAFE National Union of Coffee CRDB CRDB Bank Agribusiness and Farm DRC Democratic Republic of Congo Enterprises ECX Ethiopian Commodity Exchange NYKC New York Coffee “C” Futures FAQ Fair to average quality Contract FAS Financial Advisory Services PENSA Centro de Conhecimento em FCR Rural credit fund Agronegócios da Universidade de São Paulo FINAGRO Fondo para el Financiamiento Agropecuario PorFin Porvenir Financiero FMC Forwards Markets Commission PRM Price risk management A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector ix PROCAFE Fundación Salvadoreña para TWLB Tanzania Warehouse Receipt Investigaciones del Café Licensing Board PROMECAFE El Programa Cooperativo Regional UCE Uganda Commodity Exchange para el Desarrollo Tecnológico y UNDP United Nations Development Modernización de la Caficultura Programme PSF Permanence, Sustainability, and UNICAFEC Asociación Unión de Cafetaleros Future Program Ecológicos PTBF Price-to-be-fixed USAID U.S. Agency for International RIAS Rabo International Advisory Development Services USDA GAIN United States Department of SACCOS Savings and loans cooperatives Agriculture Global Agricultural SICOM Singapore Commodity Exchange Information Network SMS Short message service VNX Vietnam Commodity Exchange SNCR National rural credit system WCR World coffee research SOFOM Sociedad Financiera de Objetivo WRS Warehouse receipt systems Multiple x Risk and Finance in the Coffee Sector EXECUTIVE SUMMARY Millions of coffee farmers and coffee trading enterprises lack sufficient credit. This is partly due to myriad challenges and considerable costs that formal lending institutions face serving rural, often isolated markets. It is also often perceived to be the case that the inability of coffee farmers and enterprises to manage risk contributes to keeping risk-averse lenders at bay. A better understanding of coffee sector risks is needed to respond with strategies, training, and tools that can help farmers, and enterprises, mitigate their exposure to risk and strengthen their resilience against inevitable shocks. Such efforts might also assist in increasing the upstream flow of credit, catalyzing new productivity-enhancing investments, and contributing to more profitable and more sustainable livelihoods for coffee farmers. This report explores the role that producer associations, governments, non-profit organizations, the private sector, and other intermediaries can play in making risk management and financing tools more accessible and more workable for smallholder coffee growers. It examines the global coffee sector and outlines: 1) major risks and constraints facing the sector; 2) potential opportunities for improving the management of certain risks; and 3) programs launched in various regions aimed at improving access to finance. Through the use of detailed case studies taken from a number of coffee-producing countries, this report seeks to demonstrate: how risks can arise that adversely impact on the coffee sector and those working within the sector; how risks can be better man- aged so that the sector is able to improve its resilience; how financing constraints can be overcome through a variety of innovative approaches; and how there are potential opportunities to both improve risk and access to finance in a coordinated manner. The rationale for utilizing case studies is to enable best practices to be shared more widely. Even today, there are gaps in research and understanding of these subjects, and these case studies can provide a means of considering interventions and informing thinking. Many of the cases detailed in this report have not been widely shared across other coffee-producing countries, despite these countries sharing similar risks and facing simi- lar financing constraints. As such, it is the aim of this report to both raise awareness A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector xi as to the potential means for improving the management of risks, and to demonstrate innovative approaches to expanding the provision of finance to the sector. This report highlights the need for collaboration among all stakeholders within the coffee sector, both nationally and globally. Specifically, a number of the cases show that while individual actions may succeed in improving the management of one risk or reducing one of the constraints that limit financing, a more fundamental improve- ment in risk, as well as an expansion of financing, is not possible without a more holistic approach. However, where stakeholders work together to proactively tackle multiple risks and overcome multiple constraints, the impact can be dramatic. The final two cases demonstrate a virtuous circle of improved risk management that gener- ates improved access to finance, which itself facilitates further improvements in risk management. To this end, this report considers the global coffee supply chain and the actors operat- ing within it, and demonstrates, through the use of selected case studies, how collabo- rative efforts by actors and stakeholders can improve risk management and access to finance. It shows how risks can be mitigated and/or transferred between supply chain actors, and how coping can be facilitated through cooperative arrangements for when risks arise. xii Risk and Finance in the Coffee Sector CHAPTER ONE TAMING RISK AND UNLOCKING FINANCE FOR A VIBRANT COFFEE SECTOR As with other agricultural industries, the global coffee sector daily confronts risks that could hamper production, curtail potential markets, decimate margins, and even ruin entire networks of growers, roasters, marketers, traders, and exporters. The preva- lence of these risks plays a part in reducing the incentives and willingness of financiers to lend to the sector, and also curbs the interest of coffee sector actors in borrowing to invest in their enterprises. Accordingly, better risk management could well be a step toward easier access to finance. Compounding these issues is the reality that actors within the supply chain often have an inadequate appreciation of the risks they face, hampering their efforts to mitigate them and preventing adequate assessment and pricing by lenders. The objective of this report is to demonstrate how improved risk management is pos- sible and show innovative examples of actors implementing improved risk manage- ment; and demonstrate how the use of innovative lending products and processes can facilitate the expansion of lending to the coffee sector. This report also details two case studies which demonstrate opportunities for improving both risk management and access to finance in the coffee sector. However, it must be noted that not all coffee supply chain actors are equal, and not all coffee supply chains are identical. As the report will show, a range of actors within the coffee supply chain face different exposure to risks, have varied levels of ability to man- age such risks, and similarly will face various degrees of difficulty in accessing finance. Similarly, no two coffee supply chains are identical, and while all supply chains have similarities, the major differences between supply chains in countries and regions, in terms of the participants and in terms of the structure of the industry, demand that there cannot be a “one size fits all” solution to improving risk and/or improving access to finance. Any existing mechanisms to improve risk and expand finance in one loca- tion will need to be tailored to the local context. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 1 UNREALIZED POTENTIAL: ACCESS TO CREDIT AND THE COSTS AND FINANCING THE ABILITY TO MANAGE IMPLICATIONS OF RISK EFFECTIVELY IS UNMANAGED RISK NOT EQUAL The coffee sector, as with any other, has experienced In this limited credit environment, larger and more estab- tightened credit conditions during difficult financial lished borrowers are more likely to be able to access times. Perceptions of increased risk have led lenders to finance at an affordable rate. What this means in prac- cut the number of loans and the value of loans made, tice is that traders and other coffee agribusinesses face to raise interest rates, reduce exposure, and tighten lend- less challenges accessing finance than producers. While ing criteria and terms and conditions. This kind of credit traders often also struggle to find finance, many of them squeeze has hit coffee traders and, in particular, small- have collateral or income from other businesses to sup- holder farmers. port their credit requests, and many will have proven track records of proactive risk management. Producers, espe- The apparent lack of confidence in lending to the cof- cially smallholders, usually do not have collateral available fee sector is only partly due to historic repayment diffi- to secure loans and will often have the least access to risk culties and also reflects the general challenges associated management tools and procedures. with lending to agriculture and the rural sector. These challenges include: relatively high transaction costs; weak The differences in creditworthiness are also driven by the credit cultures; lack of collateral (and collateral realization nature of the coffee sector, specifically that value increases on default); and frequent climatic events that disrupt the as coffee moves along (or up) the supply chain. There is sig- industry. There is also the perception, often borne out by nificantly more value, profit, and income as one moves up events, of high risk and ineffectual risk management. the supply chain, and as such those actors are better placed to meet the lending criteria of banks and access finance The coffee trade and growers operate with a great deal (figure 1.1). Accordingly, the origin end of the supply chain of uncertainty and, as a result, must carry out their faces the greatest shortage of financing, as it generates the activities with imperfect information. Risk, therefore, lowest value. In addition, those further up the supply chain has direct negative impact on the overall profitability of are usually much more able to effectively manage their risks. their operations and their ability to access finance. Addi- tionally, while all coffee businesses are familiar with risk, It should be noted that not all actors at the same point they are often less familiar with how to quantify many in the supply chain face the same challenges. Larger pro- of these risks and, in some cases, how to manage them. ducers (estates) are often able to access sufficient finance Lenders will simply decline to lend when sector risk is and have the expertise and skills to effectively manage perceived as unacceptably high. Risk, therefore, is one many of the risks that they face. Similarly, traders vary of the main reasons that the demand for financing in the significantly in their ability to manage risks and to access coffee sector has not been met and has left many growers finance. It is commonly perceived that smaller domestic and traders without the financing to optimally run their traders can struggle to secure adequate finance and at businesses. times may be compelled to operate in a sub-optimal man- ner due to financing constraints, while larger traders with Even when risk is perceived to be at a level to encour- global reach may have access to finance both from domes- age lending, the level of risk will play a significant role tic and international banks. Similarly, global traders will in determining the interest rate charged. Lenders need often have risk management expertise that is not as readily to determine an interest rate that accurately reflects their available to their domestic counterparts. However, in gen- costs, the risks they are taking, and their profit margins. In eral it can be stated that the greatest challenge in terms of most instances, the institution determines the appropriate managing risk and accessing sufficient finance lies at the interest rate for lending to a sector and to clients. origin end of the supply chain. 2 Risk and Finance in the Coffee Sector FIGURE 1.1. INTERRELATIONSHIP BETWEEN of risks when they arise3; cases which detail improvements in RISK AND ACCESS TO FINANCE risk management; cases detailing improvements in access to Perceived funding risks finance; and finally cases that detail improvements in both Producers risk management and access to finance. Risks can be associ- Producers ated with the production process and also with the coffee Trade market itself, and the case studies here include examples Trade drawn from both categories. Enabling-environment risks cut End product End product across both production and market activities and are exam- Access to funding ined in the first two case studies here. Market risks—namely sudden and dramatic price shifts—are the focus of Case Studies 3–5, from the creation of domestic exchanges to facilitate price risk management through to technologically- driven approaches and innovative cooperative programs THE GREATEST POTENTIAL using call options. Case Studies 6 and 7 look at the risk man- FOR IMPROVEMENT IN RISK agement implications stemming from recent rust outbreaks AND FINANCE EXISTS AT in Latin America, including the use of tree replanting in Colombia in an effort to avoid repeat losses from this disease. ORIGIN Producers and domestic coffee enterprises face the most These risks and the often inadequate attempts to mitigate difficulties in accessing finance and improving their skills or manage them have served to discourage lending to the in risk management. At the same time, this end of the coffee industry, a constraint further exacerbated by its reli- supply chain also presents the greatest opportunities if ance on smallholder farm production and hence coopera- risk management can be improved sufficiently to bolster tives for processing and marketing; both groups rank well credit supply to these players. outside the traditional client bases for risk-averse formal lenders. Accordingly, finding a means to broaden access The impacts of a lack of finance in the coffee sector to finance (in addition to improvements in risk manage- have been significant, and the estimated global demand ment) is the central focus of Case Studies 8–18. Ideas for agricultural smallholder finance (not just coffee) of range from utilizing mobile banking technology and agent US$450 billion has largely remained unsatisfied.2 In addi- networks to bring formal financiers closer to the agricul- tion, the lack of access to finance is a vicious cycle in which tural smallholders, to government attempts to “crowd the lack of finance prevents coffee farmers and enterprises in” private sector funding through grants. Some projects from investing in their businesses and in risk mitigation aimed to build management capacity among growers and techniques. Easier access to financing can enable produc- cooperatives, while others aimed to address the perennial ers to improve yields as well as the effectiveness of their challenge of identifying collateral acceptable to financi- risk management, realizing significant benefits. ers. The objective is to highlight specific solutions that, with tailoring, can be successfully applied in other envi- ronments and across all relevant sectors. However, poor THE USE OF CASE adaption to local conditions and requirements can ham- STUDIES TO ILLUSTRATE per successful replication of proven approaches, as illus- IMPROVEMENTS IN RISK trated by the case study of the CFC project in Rwanda and Ethiopia (Case Study 9). AND FINANCE This report has selected case studies from across the coffee- producing world that illustrate the significance and impact 3 It should be noted that there have been a number of reports utilizing case studies that demonstrate improvements in access to finance for agriculture. Of specific note is the International Finance Corporation’s “Scaling Up Access to 2 Dalberg Report: “Catalyzing Smallholder Agricultural Finance” (2012). Finance for Agricultural SMEs Policy Review and Recommendations.” A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 3 CHAPTER TWO RISK IN THE COFFEE SECTOR The apparent increase in frequency of commodity price spikes and crop failures added to concerns over climate change have increased global interest in risk management for commodities. In addition, millions of farmers are dependent on “non-food” com- modities, including coffee, for their household income. They face both a highly risky production system and an arguably more complicated market, one that is more depen- dent on macroeconomic drivers in developed countries. For both sets of producers, the supply chains that link them to markets and their governments mean that the realiza- tion of agricultural risks can have a catastrophic impact. In addition to producers, a large number of other stakeholders are also involved in the coffee supply chains and they carry out a diverse range of activities throughout the continuum, from farm to cup. These stakeholders include input suppliers, traders, processors, banks, and finan- cial service providers, transporters, retailers, and government agencies. In one form or another, all of them are exposed to agricultural risk. Not all risks are of equal importance and, as such, it is important when considering coffee sector risks to understand how each risk affects each set of supply chain actors. This process enables a financier to understand which risks should demand the bor- rower’s closest attention. It can be helpful to classify risks into one of three principal types of risks and prioritize them based on their probability of occurrence and severity of losses. It is important to note that there are often interconnections between risks, and additionally that managing one risk may lead to the creation of another, new risk. The three risk categories are defined as: Production risks: Weather events (droughts, floods, hurricane, cyclone, sudden drop or increase of temperature, frost, and so on), pest and disease outbreaks, and so on, are major risks that lead to production volatility. Case Study 6 considers the out- break of coffee rust disease across Central America and details the adverse impact on coffee farmers. Enabling environment risks: Changes in government or business regulations, macro-economic environment, political risks, conflict, trade restrictions, and so on are A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 5 FIGURE 2.1. THE THREE PRINCIPAL TYPES while roasters and importers no doubt encounter losses OF AGRICULTURAL RISK due to such volatility, the impact is most significant for those further down the chain. Coffee is often a highly politicized commodity in producing countries and can Production entail significant enabling environment risk. Changes to Risks regulatory structures can affect all domestic activities (pro- duction through to export), while changes to research and extension services can greatly impact productivity at the Enabling farmer level. Environment M Market Risks Risks THE MAJOR RISKS AND Source: Agricultural Risk Management Team (World Bank). CONSTRAINTS IN COFFEE major enabling environment risks that lead to financial PRODUCTION AND TRADE losses. Case Study 1 considers the enabling environments It is important when considering risks to also consider of three African countries and indicates how the differ- the major constraints facing the sector. While risks raise ences in enabling environments impact upon each coun- the cost of financing and impact upon the willingness of try and their actors. Similarly, the enabling environments financiers to lend to the sector, constraints also act as a impact upon the level of risks faced by actors and, to an barrier to lending, as they raise challenges both for lenders extent, their abilities to manage these risks effectively. and borrowers. It is often the case that programs intro- duced to mitigate the risks required to improve access to Market risks: These are risks that materialize on the mar- finance will also need to consider how to overcome preva- ket level. They include commodity and input price volatility, lent constraints. exchange rate and interest rate volatility, and counterparty default risk. Often these risks have backward linkages to the A constraint is regarded as an existing condition or bottle- farm gate, thereby affecting all stakeholders. Case Study 3 neck that hampers smooth functioning of the supply chain details the challenges of establishing futures markets for cof- and leads to suboptimal performance of the supply chain. fee in producing countries, which is relevant as such markets Risks and constraints are closely linked, with constraints can offer market risk mitigation. Case Studies 4, 5, and 10 often raising the potential for a risk to arise or increasing consider price risk and price risk management, detailing the losses experienced when the risk is realized. Addition- innovative approaches for managing such risk and the chal- ally, many of the constraints limit the ability of actors to lenges faced in implementing such solutions. effectively mitigate risks. For example, in the coffee sector many countries have limited extension and research facili- While all of these risks, when they arise, have impacts ties; this is a key constraint that also worsens the impact of across the supply chain, some are often borne more by risks such as pest and disease outbreaks. Coffee trees can one set of actors than others. Production risk in coffee be left more vulnerable to outbreaks of pests and diseases impacts most greatly on farmers, as can be seen from the when a lack of effective extension results in weaker agri- recent outbreaks of rust in Central America. However, cultural practices. the impact is also transmitted to other actors in the sup- ply chain as reduced coffee production and lower quality As such, risks cannot be considered alone but rather impacts their enterprises. Another example of risks across in the context of the supply chain and its existing con- the supply chain is that of poor post-harvest handling straints, including the business-enabling environment. by farmers and by traders which reduces coffee quality and impacts throughout the chain. Market risks such as In short, an identification of risks and an appreciation of price volatility tend to impact the origin, processing, and constraints can help provide a framework by which sup- exporting parts of the supply chains most severely, and ply chain actors can determine where to focus their efforts 6 Risk and Finance in the Coffee Sector on managing risk. This does not necessarily mean that tect against coffee price volatility by using coffee futures any risk can be eliminated but, rather, managing risk is an contracts (traded on commodity exchanges). However, approach that can help reduce or contain the impact of these instruments come at a cost and also represent an risk when it is realized. In addition, there is often a cost in opportunity cost as they eliminate the potential for users managing the risk and each person or enterprise will need to take advantage of upswings in the market. It is also to determine whether the cost is worth the protection important to note that often a risk management tool may offered. For example, sector participants can seek to pro- not fully protect against total risk. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 7 CHAPTER THREE FINANCE AND THE COFFEE SUPPLY CHAIN The scale of the financing needed to facilitate the global coffee trade emerges when considering that in 2013 exports totaled 6.66 million tons of green coffee, valued at US$17.91 billion, while a further 2.68 million tons were sold domestically.4 It is help- ful to consider financing of the coffee supply chain by considering the financing needs and the availability of financing for actors at each stage of the chain. As noted in Chapter One, lenders perceive that risk is greatest at the origin end of the coffee sup- ply chain, which at least partly explains why access to credit is easier for those at the retail end of the chain than for producers. Table 3.1 shows the needs, duration, and providers of finance at each stage of the value chain, both in producing and consuming countries. It also illustrates that actors at different stages of the value chain have a different range of financing sources avail- able and require different types and durations of finance. There exists a wide range of lenders involved in providing financing to the sector, both formal (regulated financial institutions) and informal lenders (unregulated individuals and organizations who provide finance). Formal lending institutions include banks, microfinance institutions, credit unions, and other types of financiers, while informal lenders include moneylenders as well as other value chain actors who provide financ- ing to secure supplies of coffee. It is notable that inter-value chain lending is a critical element of the financing arrangements of some actors. For example, a great many traders and collectors provide financing to farmers at the start of the season to secure access to their coffee, and many of these traders in turn receive financing from the exporters who similarly wish to secure their own supplies. Depending on the local market conditions, some exporters may at times receive financing from their import- ers. What is common to the inter-value chain lending flows is that all lending is based upon the needs of the actors to lock in supplies of coffee.5 4 Source: ICO. 5 Source: Coffee Supply Chain Risk Assessments (Haiti, Uganda, Vietnam)–The World Banks’ Agricultural Risk Man- agement Team (ARMT) undertook three coffee supply chain risk assessments and published these documents on the World Bank website. Each of the three reports was a specific study of the risks in each specific country. The reports are available via the World Bank website. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 9 TABLE 3.1. SUPPLY CHAIN ACTIVITIES AND FINANCING SOURCES AND REQUIREMENTS Providers Common Value Types Reason for Activity of Credit Chain Actors Duration of Finance Finance Production Moneylenders, credit Small, medium, and Short-/ Pre-harvest finance, Land preparation, unions, banks, traders, large producers, Medium-term seasonal loans crop maintenance, input suppliers cooperatives harvest Purchase Banks, exporters Traders, middlemen, Short-/ Overdraft; Capital to purchase exporters, Medium-term collection coffee cooperatives credits and stock Funds for storing advances coffee Fixed operations costs Processing Banks, credit unions, Traders, cooperatives, Short-/ Operating finance Storage of coffee exporters processing facilities Medium-term Operations of coffee mill Fixed operations costs Export Banks, multinational Exporters, Short-/ Trade finance Storage of coffee buyers and importers cooperatives, large Medium-term Pre-shipment Transportation of traders finance coffee Importers/ Banks Roasters Short/ Operating finance Operations of roasting Roasters Medium-term facility Working capital There is a mix of financing required both in terms of the borrowers (enterprises versus farmers) and also the duration and purpose. As a rule of thumb, the shorter the nature of the activities being financed, with financiers maturity of the loan required, the easier it is to access the much more comfortable lending to activities where the finance. For example, it is commonly perceived that pro- coffee (the underlying commodity being financed) is on ducers will more easily secure harvest finance than pre- hand and can be utilized as collateral. In addition, the harvest finance or longer-term financing for investment. availability of finance varies markedly based on the loan The vast majority of financing is for short-term purposes, term. All things being equal, the shorter the loan maturity, namely for coffee trading (collection, processing, export- the greater the availability of financing, with longer-term ing, importing). Longer-term financing usually is required loans being perceived as carrying far greater risk. Case for investment in production facilities. Study 12 considers how the Honduran government’s Rural Competitiveness Project (COMRURAL) facilitated access to longer term loans for investment purposes by AVAILABILITY OF FINANCE coffee sector cooperatives, utilizing a matching grant pro- It is clear that not all actors in the coffee supply chain gram to encourage lending by banks. have the same level of access to finance and that a short- age of finance can greatly impact the efficiency of actors However, one must also acknowledge the different expe- in undertaking their coffee sector functions. Availability riences in accessing finance among actors at the same varies based on both position in the supply chain and the level of the chain. For example, exporters often vary sig- duration of loan, with those further up the chain gener- nificantly in their ability to access finance, in the range ally having much easier access to more affordable rates of financing options, and in the rates, fees, terms and of finance (figure 3.1). This is both due to the nature of conditions applied. Most dramatic are the differences in 10 Risk and Finance in the Coffee Sector FIGURE 3.1. AVAILABILITY OF FINANCE Bankability Constraints » Limited financial literacy of potential borrowers » Lack of borrowing or credit history of bor- Short term rowers » No or limited (realizable) collateral » Remoteness of producers and enterprises in rural Availability of finance Loan areas as regards formal banking services maturity » High transaction costs/low profitability of lending to small borrowers (producers) » A lack of credible aggregated associations of Long term smallholder farmers (to overcome transaction cost issues) Origin Retail Position in value chain Enabling Environment Constraints » Regulatory challenges of lending to the coffee and finance availability between domestic export operations agricultural sectors and subsidiaries of multinational firms in terms of their » Historical performance issues when lending to the ability to access finance. Multinational exporters (and coffee sector (including debt forgiveness programs their subsidiaries) often have access to lower-cost funds and a history of non-performing loans) from across the globe and may have the ability to borrow not just from banks but also from a large range of non- Constraints are highly significant and can be seen from bank financial institutions (if not from their parent com- two sides: the ability of the banks to lend to the coffee pany). Domestic exporters, by contrast, could be faced sector, and the ability of coffee sector actors to borrow with much more expensive loans, with far more strin- from the banks. The most successful programs to expand gent lending requirements. The same is true of farm- lending by tackling risks also often involve reducing the ers. Smallholders, typically with a few hectares of coffee impediments to finance imposed by the constraints. For trees, might struggle to secure bank lending, whereas example, the lack of realizable collateral held by cof- a much larger coffee estate will often find more wiling fee farmers often is a major barrier to the provision of financiers. Case Study 11 considers Brazil’s CPR, a trad- financing. Banks generally will not lend without sufficient able receipt, that expanded access to finance for coffee collateral that can be realized in case of default, both to sector participants. meet internal lending rules and also to meet central bank requirements on loan classifications. As such, some inter- ventions aimed at improving access to finance will directly CONSTRAINTS IN ACCESSING address the lack of realizable collateral while also tackling FINANCE risks that impact on farmer profitability; a combined con- While it is helpful to view funding availability based on straint and risk approach. A good example of this holis- the coffee supply chain, its actors, loan duration, and tic approach is the project implemented in Rwanda and the level of risk, it is also imperative to consider some of Ethiopia for smallholder farmer cooperatives that pro- the existing constraints specific to the coffee sector that vided guarantees as an alternative to realizable collateral. can similarly limit access to finance. As the case studies This is detailed in Case Study 9. Similarly Case Study 17 demonstrate, many of the interventions aimed at improv- examines the Por Fin Project which worked to improve ing access to finance often consider risk management the financial literacy level of coffee sector cooperatives, alongside interventions to overcome existing constraints. thereby tackling a major constraint in lending to such Constraints include: enterprises. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 11 CHAPTER FOUR THE DYNAMICS OF RISK AND FINANCE The case studies strongly suggest there are numerous opportunities to improve risk management and better facilitate access to finance for actors across the coffee sector. Indeed, the case studies contained in this compendium illustrate that actors across the coffee supply chain have been and continue to be focused on addressing individual risks and constraints, including a paucity of finance, that are considered to hamper the full potential of the industry. Some efforts have focused purely on production risks, such as disease outbreaks or climate impacts, while others have sought to reduce the potential for similarly catastrophic price falls in coffee markets or state-instigated changes to regulations and laws. However, this report also considers the inter-relationship between risk, finance, and other constraints. Specifically, it addresses the opportunities that improved risk man- agement can have for expanding access to finance, and how improved access to finance can enable investment in risk management for the sector. In essence, this becomes a virtuous cycle with improvements in risk management leading to reduced exposure to losses from risks when they arise, that result in improved access to finance, which itself enables investment in improved risk management. In the case of Root Capital (Case Study 13), the lender undertook responsibility for encouraging and guiding cooperatives in their choice and use of credit products and graduating the borrowers to more complex and longer-duration loans in line with their success and their growing needs. Similarly, Sustainable Harvest (Case Study 5) provides an example of an importer that set out to encourage cooperatives in Latin America to become more adept at managing their price risk exposures by facilitating their use of call options. The example of Twin Trading (Case Study 18) emphasizes the opportunities that arise when a buyer invests the time and effort in facilitating introductions and relationship building between suppliers and lenders. Building on such instances of symbiotic relationships within the coffee supply chain, the report concludes with two case studies (19 and 20) that highlight the positive relationship between improvements in risk management and improvements in finance. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 13 Specifically these are brought about by a “tightening” of the producer gaining in income potential while the buyer the supply chain, with increased collaboration between benefits from secure coffee supplies. This mutually ben- the supply chain actors, which result in improved risk eficial approach to risk and finance often also includes management and improved access to finance. In both the tackling of other sector constraints (for example, lack cases, it is evident that there is a strong mutual benefit of extension, research, and training), while the improved that derives from this supply chain collaboration, with productivity of all actors justifies the costs involved. 14 Risk and Finance in the Coffee Sector CHAPTER FIVE CASE STUDIES Enabling Environment 1. The Importance of a Supportive Enabling Sector Environment: Uganda, Tanzania, and Kenya—A Comparative Case Study 2. The Value of Regional Private/Public Sector Initiatives: The Example of the African Fine Coffees Association (AFCA) Market Risk 3. Futures Markets in Coffee-Producing Countries 4. Implementing Price Risk Management in the Rwandese MarketPlace 5. Minimizing Price Risk Through Variable Sales Using Call Options Production Risk 6. The 2012 Latin American Coffee Rust Outbreak: “Black Swan” or “New Normal”? 7. Recent Experiences of Coffee Replanting Programs in Colombia Improving Bankability for Coffee Sector Borrowers 8. Utilizing Technology and “Boots on the Ground” to Reach New Customers in India: The Sub-K Approach 9. Farmers’ Access to Credit through the Use of Credit Guarantee Services: Experience of Coffee Farmers in Ethiopia and Rwanda 10. Incorporating Price Risk Management into the Lending Operations of a Tanzanian Bank—2005–07 11. Cédula Produto Rural: A Tradable Receipt in Brazil 12. COMRURAL Honduras—Crowding in Commercial Banks through Matching Grants 13. De-risking the “Missing Middle”—the Case of Root Capital, a Socially-Ori- ented Lending Institution 14. Warehouse Receipt Systems in the Coffee Sector: African Experiences A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 15 FIGURE 5.1. AVAILABILITY OF FINANCE Annual production by crop year thousands of 60 kg bags KENYA TANZANIA UGANDA 4000 3000 2000 1000 0 1 2 3 4 5 19 96 19 /97 19 /98 19 /99 20 /00 20 /01 20 /02 20 /03 20 /04 20 /05 20 /06 20 /07 20 /08 20 /09 20 /10 20 /11 20 /12 3 /9 /9 /9 /9 /9 /1 / 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 19 19 19 19 19 19 Source: ICO. Aggregation: the Challenges and Opportunities on coffee production that were, in part, driven by different to Increase Finance market structures, economic factors, and regulatory envi- ronments. Evidence suggests that in a country with a less 15. The Benefits of Modernizing a Costa Rican Cof- challenging regulatory environment, the coffee sector could fee Cooperative: COOPETARRAZU perform better in terms of production7. However, it also 16. Nsangi Coffee Farmers Association, Uganda notes that other factors including other economic activities 17. Strengthening the Financial Capacity of Small- may reduce the attractiveness of producing coffee.8 holder Businesses: The PorFin Project 18. Facilitating Lending to Smallholder Producer Compared with the early 1990s, coffee production Groups—The Twin Approach has grown strongly in Uganda, remained more or less unchanged in Tanzania, and dropped sharply in Kenya Value Chain Approaches to Risk Management (figure 5.1). The question to consider is what has driven and Finance these different production outcomes, particularly as much 19. Evolving Supply Chain Management: An Exam- of Kenya’s coffee sells at above-average prices.9 ple From China 20. Extending Access to Finance through the Use of Differences in Market Structures and Supply Chains Regulatory Environments CASE STUDY 1: THE Uganda—a move to a less regulated environ- ment: The collapse in 1989 of the 26-year interna- IMPORTANCE OF A tional system of coffee export quotas left many countries SUPPORTIVE ENABLING ill-equipped to deal with free market conditions, which SECTOR ENVIRONMENT:6 brought sharp price falls as accumulated surplus stocks UGANDA, TANZANIA, AND were released. During this upheaval, a number of then- existing marketing monopolies eventually ceased to KENYA—A COMPARATIVE CASE STUDY 7 While this case study is not specifically about the risk of an adverse enabling This case study considers the experiences of three East Afri- environment, it aims to show how a more facilitating regulatory environment can coffee-producing countries and their respective perfor- can positively impact the success of a coffee sector when compared to other less conducive environments. mances over the past two decades. It reviews the impacts 8 For example, the discovery and exploitation of energy sources could drive up domestic exchange rates, negatively impacting coffee production and export 6 The term “enabling environment” refers to a set of interrelated factors that unless otherwise mitigated. are often but not only government policies or actions, which jointly and sever- 9 Uganda and Tanzania produce both Arabica and Robusta. Kenya only pro- ally influence the ability of a coffee sector and its stakeholders to prosper. duces Arabica, although trials to grow Robusta are underway. 16 Risk and Finance in the Coffee Sector function, including the Uganda Coffee Marketing Board. Production of Coffee in Each Country Today Its withdrawal in 1991 ultimately caused most Ugandan cooperatives to collapse or exit the coffee business with Kenya is economically the most developed of the three major debts, leaving the sector as a whole in consider- countries, with high demand for both real estate and labor able disarray. Having previously been turned into little around major centers. Production is divided between more than buying agents for a Marketing Board that set commercial estates and smallholders, with the former cul- fixed prices for the season, the vast majority of coopera- tivating around 38,000 ha in the early 1990s and the latter tives proved unable to cope with fluctuating prices in a around 122,000 ha.12 By 2012, however, these measures liberalized market and the accompanying resurgence of had fallen to about 24,000 ha and 85,000 ha respectively. both domestic and international private sector competi- Driving these changes has been a large-scale conversion tion. As a result, much of the supply chain (that now con- of estates near main centers to commercial and residen- sisted almost entirely of widely-dispersed smallholders tial use. While there have been some similar conversions and inexperienced intermediaries unable to develop new of smallholder farms, much of the reduction in this sector strategies to cope with the new realities) lost its erstwhile is attributed to waning interest in coffee growing. This is cohesion, leading to a dramatic reduction in the provi- surprising given that smallholders produce some of Ken- sion of key services such as extension, input supply, and ya’s best coffees, fetching very high prices internationally. credit. However, despite the upheavals that accompanied However, yields are low, with average production in 2012 the industry’s liberalization, the farmers’ share of export on estates around 1 metric ton per hectare (MT/ha) and value rose strongly; today, Ugandan farmers on average that for smallholders just 367 kilos.13 Unsurprisingly, cof- receive between 70 percent and 80 percent of the value fee export revenues have fallen from first to third place free on truck Kampala.10,11 nationally, well behind tea and horticulture.14 Most coffee continues to be marketed through weekly auctions, but a Tanzania and Kenya—continued government second window also allows direct sales. ICO data put total regulation, support, and oversight: In Kenya and 2012/13 production at 767,000 bags15 compared with Tanzania, the long-established central auction systems 1.49 million bags in 1990/91. (through which all coffee was transacted on a willing seller–willing buyer basis) had provided a relatively stable The internal marketing chain is complex with a string of and continuing framework before the end of the global intermediaries. This is especially so for smallholders as quota system. While increasingly seen as a constraint by some 200 cooperative societies handle a relatively small some, at the time those systems were arguably better able amount of coffee that is delivered as fresh cherry. (Total to deal with the shocks that arose from the lifting of export production of 31,000 MT green bean in 2011/12, on quotas. This enabled the coffee supply chain in these coun- average around 150 MT green bean per cooperative.) tries to retain its cohesion to a significant extent, and to This is then channeled to the auction through a number function more or less as before, albeit also at lower prices. of cooperative unions, millers, and marketing agents. Fragmentation, small farm sizes, and a frequent lack Despite the Ugandan coffee sector experiencing the most of good corporate governance all contribute to low dramatic changes from the end of the global quota sys- smallholder productivity, as does the apparent failure tem, it is all the more surprising that Ugandan output to fully exploit the potential of Kenya’s relatively well- should today outstrip that of both its neighbors, not just developed savings and loans cooperatives (SACCOS) in in Robusta but also for Arabica coffee. terms of channeling payments and providing financial 10 The cooperative system has a long history in all three countries. It continues 12 Kenya produces Arabica coffee. to be a major factor in both the Kenyan and Tanzanian coffee sectors despite 13 Source: CBK Data. a number of constraints and, particularly in Kenya, incidences of corruption 14 2012 Kenyan Export Figures show exports of Tea ($910m); Cut Flowers causing many farmers to complain they receive too small a share of the actual ($591m); Coffee ($281m). Source: http://atlas.cid.harvard.edu/explore/tree_ auction price. map/export/ken/all/show/2012/. 11 For comparison of share of revenue going to farmers, see table 5.1. 15 There are just over 16.6 bags (of 60 kgs) in a metric ton. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 17 services to individual coffee growers. Finally, farmer In Uganda, there have in recent years been severe set- revenues are subject to a number of taxes and levies, backs to the industry, particularly from wilt or die-back totaling 4.1 percent. disease in the Robusta sector, all in addition to the dra- matic changes following the end of the global quota sys- Tanzania has more agricultural land than Kenya, and in tem. Nevertheless, the sector as a whole has shown strong most coffee growing areas there is less population pressure. resilience to bring it back to erstwhile production levels, Although Tanzania has always produced some Robusta, rising from about 1.96 million bags in 1990/91 to about output traditionally consisted of Mild Arabica, with small- 3.20 million bags in 2012/13. Furthermore, whereas holders delivering about 90 percent of total output from previously Arabica accounted for only a small share of farms ranging from 0.5 ha to 3 ha, with some 110 estates national production, it now represents around 22 percent accounting for the remainder.16 In recent years, total pro- of total exports (2012/13) compared with about 14.5 per- duction has more or less stagnated, but at some 40 percent cent in 1998/99. This incidentally means Uganda cur- of the national total in 2011 the share of Robusta had rently is not only East Africa’s largest coffee producer risen to double what it was in 1990. This does fluctuate overall (and the second-largest in Africa after Ethiopia) however, in part due to unrecorded exports to Uganda. but that it also is on track to become the single-largest Arabica production in the south is being extended, given exporter of Arabica in East Africa, overtaking Tanza- the availability of suitable land. The recently launched nia and almost equaling Kenya. However, unrecorded Tanzania National Coffee Industry Development Strategy imports of Arabica from the Democratic Republic of aims to increase production to 100,000 MT by 2021, in Congo (DRC; where a 15 percent provincial export tax part by raising productivity from the current average of applies) and Robusta (from both the DRC and Tanzania) just 225 kg/ha (Arabica and Robusta combined). play a certain part in this. The majority of smallholders (450,000 families who produce In contrast with its neighbors, Uganda levies only a about 90 percent of Tanzania’s coffee with estates providing 1 percent tax on coffee proceeds. The licensing and over- the balance17) process on-farm to the parchment stage and sight regime in Uganda is light, with the Uganda Coffee deliver to their primary society or private collectors; how- Development Authority only intervening in industry opera- ever, cherry is also delivered to a number of central process- tions when serious issues arise. Accordingly, there are no ing units or wet mills. Prior to 2003, exporters bought and real restrictions on who operates where, or who does what. milled parchment directly, a practice that ceased with the As a result, the marketing chain is both simple and effi- introduction of the “one license” rule, meaning exporters cient, which is as well, considering Uganda is landlocked were no longer able to also act as collectors or millers. and exports have to travel in excess of 1,000km to reach the Indian Ocean ports of either Kenya or Tanzania. Nev- The bulk of Tanzanian coffee is marketed through ertheless, Uganda is also arguably disadvantaged by having weekly auctions, but, as in Kenya, there is also a second relatively weak coffee research facilities in place, especially window permitting direct sales if the price matches or is when compared to the much larger research services of better than what comparable quality obtains in the auc- Kenya and Tanzania.18 tion. The marketing chain is subject to a complex system of licensing and different statutory deductions total- Farmer aggregation. Farmer aggregation is often ing 6.1 percent. The Tanzanian cooperative sector also seen as the best way to enhance smallholder viability by faces issues and constraints similar to those that prevail providing farmers with improved market access, better in Kenya, but not to the same extent. ICO data put total 2012/13 production at 1.02 million bags compared with 18 A 2010 World Bank report noted only five full-time researchers were sta- 932,000 bags in 1990/91. tioned at the then Ugandan Coffee Research Center that was also responsible for research in tea, cocoa, and palm oil. Today, however, Coffee Research Cen- ter is once again the purview of a stand-alone institution (the National Cof- 16 Tanzania also produces a small amount of Natural or Sundried Arabica. fee Research Institute, or NaCORI), and plans are in advanced stages for its 17 Source: Tanzania Coffee Board—www.coffeeboard.or.tz. adequate staffing and funding. 18 Risk and Finance in the Coffee Sector agronomic extension and input services, and, particularly grower payments ranging from three months to, in some in recent years, as a route to entry into sustainability stand- instances, up to 1 year.21 ards. However, the history of the cooperative movement in many countries is mixed in terms of performance, sus- Commercial growers or estates, on the other hand, generally tainability, and effectiveness in improving the position of present coffee to the auction directly, and as such they also farmers. receive the sales proceeds directly, less statutory deductions. In Kenya, much of the coffee cooperative sector is not In Tanzania, farmer organization also takes the famil- only inefficient but also subject to corruption and politi- iar form of primary societies at the village level, organ- cal interference at different levels. The erstwhile apex ized regionally under umbrella cooperative unions. These organization, The Kenya Planters Cooperative Union, latter groups are responsible for financing, transporting, was placed under receivership in 2009, leaving a leg- marketing, and supervising the sale of coffee supplied by acy of unpaid debts including non-payment for coffee their primary societies. Currently, Tanzanian coopera- delivered by individual cooperative societies. As a result, tives account for some 90 percent of total production. In many co-ops remain in poor financial health. Kenyan recent years some primary societies have broken away smallholders are required by law to deliver their cof- from their unions to form separate entities; for example, fee to cooperatives and are prohibited from selling, for to join third party certification schemes such as Fairtrade, example, to private processors. Nonetheless, side-selling but also in order to have more control over their own or “hawking” still occurs.19 affairs and to access the second window for direct sales. Furthermore, the traceability of both coffee and proceeds Furthermore, in many instances the bulk of local added provided by the auction system and its negotiable ware- value (which is substantial on premium Kenyan coffees) house receipts system has enabled cooperatives to raise accrues at the marketing and export levels, whereas the short-term finance against coffee stocks pending sale. final net remuneration per grower varies widely depend- Nevertheless, Tanzania’s National Coffee Development ing on which cooperative union or society handles the Strategy 2011/2021 aims to strengthen both the capacity grower’s coffee and its proceeds, with some growers and efficiency of cooperatives generally, recognizing that receiving minimal returns. Previous attempts to improve not all work well and that some areas need improvement. the cooperative payment system (such as under the sec- ond phase of the Smallholder Coffee Improvement Proj- In Uganda, there are increasing signs in recent years of ect20) achieved mixed success in different areas, mainly farmers voluntarily creating farmers’ groups or associations due to having to deal with poor management structures to fill the vacuum left by many erstwhile cooperatives. This and a lack of adequate capacity to administer funds is mainly to access some extension support and to benefit effectively. However, there are encouraging signs in from certification, and in so doing improve the market- areas where the payment systems these initiatives pro- ability of their coffee. Donor and government support is moted have become well-entrenched. In addition, leg- increasingly channeled to such groupings of which there islation now stipulates that cooperatives may deduct no now may be close to 1,000 different sizes and capabilities more than 20 percent from their total gross proceeds (possibly accounting for between 5 percent and 8 percent to cover processing and overhead expenses. Yet reports of total production), suggesting they are beginning to make persist of both unauthorized deductions and delayed an impact. This appears to be a positive development, although only time will tell which will be sustainable and whether the necessary internal cohesion can be achieved to safeguard the integrity of group finances. 19 See, for example, A. Mude, Dismal Performance of Kenya’s Coffee Cooperatives—2006; and Miriam Vorlaufer et al., Determinants of Collective Marketing Performance: Evidence from Kenya’s Coffee Cooperatives—2012. 20 Second World Bank “Smallholder Coffee Improvement Project.” http: See, for example, “The impact of Coffee Certification on farmers in Uganda, 21 //www.worldbank.org/projects/P001265/smallholder-coffee-improvement- Kenya and Ethiopia” by CIDIN: Centre for International Development Issues project?lang=en. Nijmegen. Radboud University of Nijmegen for Solidaridad—February 2014. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 19 TABLE 5.1. COFFEE INDUSTRY CHARACTERISTICS OF KENYA, TANZANIA, AND UGANDA Approx. Farm Gate GDP Per Price as % of Export Taxation & Licensing/ Marketing Farmer Capita1 Values Levies2 Oversight System Aggregation Kenya 1,736.9 Estates around 90% of the 4.1% Complex and Closed—central Weak cooperative auction value highly regulated auction/ sector Smallholders extremely limited direct Corruption variable, ranging from sales Smallholder sector 70% to much lower3 highly politicized Tanzania 1,574.8 Between 65 to 70% of the 6.1% Complex and Closed—central Relatively weak FOB value but variable highly regulated, auction/ cooperative but review is limited direct sector; some ongoing sales political interference Uganda 1,329.8 Between 70 to 80% of the 1.0% Straightforward Open Growing trend Free on Truck Kampala and lightly All direct sales toward farmer value regulated aggregation Little political interference 1 World Bank Development Indicators 2012. 2 Coffee exports do not attract Value Added Tax, but some value chain services do. 3 Recent ICO statistics do not feature prices paid to growers in these three countries, and the data for this table are from different sources plus own estimates. Kenya estates are paid directly but of course cover their own overheads and processing costs whereas smallholders supply fresh cherry. Also note that particularly for high quality Kenyan smallholder coffee, there is reportedly a large amount of added value between sale in auction and export, making a direct comparison with Tanzania and Uganda difficult. Some market participants consider the formation of other local government activities. This encourages diver- intermediary entities as cooperatives and associations sion where informal cross-border transits are physically as bringing additional layers of bureaucracy into the possible, which to some extent probably has contributed marketing chain. Nevertheless, the basic functions they to at least some of Uganda’s progress. Alternatively, as is perform are essential and are in effect the same as those demonstrated by the case of Kenya’s coffee sector, farmers performed by private buyers in the process of assembling may exit coffee in favor of other crops that are either not the coffee produced by growers, processing it, and trans- as highly taxed or whose farm gate prices are higher due to porting it to the market, be that at an auction or for direct the absence of “deductions” by an often non-transparent export. The real issue is the degree to which these entities cooperative movement, as encountered in coffee.22 can and do represent grower interests transparently, hon- estly, and in an efficient manner (efficiency is critical as Complex licensing and restrictive oversight often the greater the efficiency of the activities, the greater the result in reduced competition and encourages inefficiency grower’s share of the sale value of the coffee). Neverthe- in marketing chains. Exporters in both Kenya and Tan- less, there is some evidence to suggest that if such entities zania are prohibited from participating downstream from function correctly, they can play a major role in advanc- the auction, whereas in Uganda they are free to purchase ing smallholder interests. from local collectors. Some multinational coffee groups in Uganda are now engaging in actual production as well. Taxation levels detract from coffee’s attraction in both Kenya and Tanzania, particularly so where growers feel The gross domestic product (GDP) figures demonstrate the much higher level 22 they are not benefiting from the taxes and research levies of economic activity and therefore alternative economic opportunity in Kenya, they pay, especially local levies for roads maintenance and particularly when compared with Uganda. 20 Risk and Finance in the Coffee Sector This generally raises the competition for coffee at the farm capacity. In Uganda, development partners are increas- gate and drives up the returns available to farmers. Follow- ingly working with the private sector through matching ing Tanzanian independence in 1962 and the imposition of grants to encourage moves toward value chain partner- export quotas in 1963, the state became a significant pres- ships between the private sector, farmer groups, and the ence in the coffee sector, posing regulatory challenges for public sector. This approach has managed to leverage commerce. Until 2014, the coffee sector was still subject to resources for both impact and sustainability of the effort no less than 15 different types of licenses, and the adverse and could in time perhaps also impact positively on the impact of this regulatory environment was recognized in ability of farmers to raise finance independently. the Tanzania National Coffee Industry Development Strat- egy, which states, “the business climate can be improved.” In Tanzania, there are signs of an emerging realization of the need for change and for a more encouraging envi- Marketing systems are likely to be more efficient when ronment for public and private partnerships, recognized open and transparent at all levels. This is not to say that once again in the National Coffee Development Strategy. central auctions are not efficient price discovery mecha- In Kenya, on the other hand, major changes to broad nisms (although the time gap between delivery and sale agricultural oversight functions, including the proposed can be substantial and as such, exacerbates exposure to absorption of the Coffee Board of Kenya into a newly price volatility risk), but without a tamper-proof mecha- formed Agricultural, Fisheries and Food Authority with nism to transfer the proceeds to the farmers, multiple lay- numerous responsibilities, might well impact the timing ers after final sale result in additional costs that reduce the of necessary reform of the current regulatory regime.23 end-price received by the farmer. This is the main rea- son why so many of Kenya’s smallholders complain of This study provides a brief sketch of three different sector receiving very low prices, even when much of their coffee environments. Two maintain a highly regulated approach realizes high prices in the central auctions. There are a that many consider impacts adversely on the health and number of reports of farmers exiting coffee production growth of the coffee sector, with the third more lightly for crops of potentially lesser value but for which they regulated while the state nevertheless provides a neces- receive cash on delivery and a greater share of value. sary minimum level of oversight. However, for all three countries, low productivity remains a concern, alongside ageing farmer populations and exposure to risks posed by Conclusion both climate change and price volatility. Success in improving farmer incomes and attracting investment into the coffee sector is, to a large extent, dependent not only on the prevailing environment in a CASE STUDY 2: THE VALUE coffee sector but also on the presence of alternative eco- OF REGIONAL PRIVATE/ nomic opportunities that may be more attractive (as seems PUBLIC SECTOR INITIATIVES: to be the case in Kenya). Where the regulatory environ- ment is generally considered cumbersome, it is more chal- THE EXAMPLE OF THE lenging to encourage farmers to invest in their production AFRICAN FINE COFFEES (or to continue growing coffee), and similarly challenging ASSOCIATION to encourage private sector actors to invest in additional Overview coffee sector activities. This case study examines the ways in which the African Fine Coffees Association (AFCA, previously EAFCA) has As a result of its simpler regulatory framework, the evolved beyond its initial role as a regional coffee sector Ugandan coffee sector has in recent years benefited from organization focused on marketing, policy, and sector significant private sector inflows (with direct investment in both production and processing), accompanied by a 23 See Agriculture Sector Functional Analysis—A Policy, Regulatory, and Leg- number of development programs focusing on productiv- islative Perspective by: Abraham Rugo Muriu, IEA Kenya, and Hillary Biwott, ity, quality enhancement, and generally building grower IILA Kenya. See www.internationalbudget.org/wp-content. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 21 advocacy to being able to add substantial value to the pro- » Addressing these challenges required a regional, cess of improving coffee sector environments in individual apolitical sector body, not only to promote fine cof- countries. Of specific interest with regards to improving fees from Africa but also to collaborate with gov- the enabling environment for coffee—and managing ernment authorities in producing countries and enabling environment risk—is the policy dialogue con- to liaise with important interregional bodies else- ducted by AFCA on behalf of their sector membership. where, such as the specialty coffee associations of America, Europe, and Japan. While many of AFCA’s activities could have been under- taken directly by each member country, the Association Incorporated in Uganda in 2000 with both public and pri- has proven adept at undertaking these on behalf of all vate members from Burundi, Ethiopia, Kenya, Rwanda, its members by aggregating resources and aligning them Tanzania, and Uganda, the initial objectives were to with emerging opportunities. It has also displayed an abil- address the following challenges: ity to attract donor funding for its activities, bolstered by » A lack of institutional arrangements in addressing the introduction of the now prominent annual AFCA cof- issues affecting specialty coffees fee events.24 A growing realization by policymakers and » Inadequate quality/specialty coffee orientation industry bodies that AFCA represents a worthwhile and among many producers knowledgeable discussion partner has enabled the Associ- » Inadequate coordination with research institutions ation to assist with the development of appropriate sector and limited technology transfer policy and regulation in different African coffee-producing » The need to better understand both the market countries. This confirms that regional private/public ini- and the product and to join the specialty and sus- tiatives can bring both positive results and greater expo- tainability movements that were afoot at the time sure. Other coffee-producing regions would benefit from » Generally weak linkages with both the international this example by embracing the view that the sharing of trade and roasters knowledge, and experience, augmented by active promo- tion, can bring benefits to all. AFCA’s case also highlights Resource constraints made these objectives difficult to that only major coffee-producing countries can catalyze achieve by individual countries, demonstrating the need the large-scale attention and exposure that AFCA has for a regional industry organization. achieved for its smaller coffee-producing member nations. By 2003, another five country chapters had already been Background established in the Democratic Republic of the Congo, The Eastern African Fine Coffees Association, the precur- Malawi, South Africa, Zambia, and Zimbabwe. In 2012, sor to today’s AFCA, was established in 2000 as a result AFCA transformed itself into a pan-African organization of an initiative by coffee professionals from different back- with members joining from Cameroon and African and grounds who held to some common views, namely: Malagasy Robusta Coffee Agency (ACRAM), a body that » As the birthplace of both Arabica and Robusta brings together African Robusta producers. coffee, Africa is home to a wide diversity of unique coffees. However, to benefit from this advantage, By early 2014, AFCA had country chapters in 11 coun- producers needed to understand their markets and tries and 252 members, ranging from individuals to com- buyers better. panies and public entities.25 » The future belonged to the organized. This pre- sumption was already well appreciated in East How was this achieved? Africa, but numerous challenges remained that af- In 2002, the U.S. Agency for International Development fected all African coffee-producing countries. (USAID) began supporting AFCA due to concerns that 24 In 2014, AFCA was, however, entirely self-funded for all its administrative 25 AFCA chapters: Burundi, DR Congo, Ethiopia, Kenya, Malawi, Rwanda, and operational costs, and it funds a large proportion of its program activities South Africa, Tanzania, Uganda, Zambia, and Zimbabwe. A new chapter is from internally-generated income. being established in Cameroon. 22 Risk and Finance in the Coffee Sector the East African coffee sector was failing in the wake Fine Coffee Conference and Exhibition and organized of a global glut of extremely low-priced mainstream or trade missions for its members to selected import markets commodity-type coffee. This assistance (initially through to enhance market linkages and business relationships. the Regional Agricultural Trade Expansion Support Pro- AFCA also hosted “Meet the Buyer” cocktail events in gram, and subsequently through the Competitiveness conjunction with international coffee events and estab- and Trade Expansion Program) enabled AFCA to show lished networking “Coffee Clubs” in its member countries. the value of bringing together industry stakeholders from across the region to focus on both improving product AFCA conducted annual national cupping competitions quality and raising the profile of the region’s truly unique and regional “Taste of Harvest” events to promote aware- coffees. This was done by establishing and promoting a ness of fine coffee within member countries and enhance network in the Eastern Africa coffee-growing region to: coffee quality. These competitions evolved into the “Afri- » Exchange information and promote the produc- can Taste of Harvest Competition,” and as a result of tion, processing, export, and consumption of the this, the very first Cup of Excellence Competition and finest quality coffee through education and train- Auction in Africa was held in Rwanda in 2013.26 ing for coffee professionals and other stakeholders. » Encourage the development, establishment, and Training has been expanded using the AFCA-developed implementation of a modern, regional marketing “Know your Cup” sessions in which farmers, traders, and infrastructure in order to: processors are informed about coffee quality and grading, » Increase the purchasing power of coffee growers and how to improve quality, including the basic premise » Improve buyers’ accessibility to fine coffees from that “coffee is food” and should be treated as such. On the the region domestic consumption side, AFCA, through its national » Promote the rewarding of coffee quality with chapters and members, organizes barista training and premium prices barista championships to promote both the brewing and » Improve industry accountability, transparency, consumption of fine coffee. and professionalism Even so, following a review of AFCA activities, a new » Liaise with any organizations on matters relating strategic plan was adopted for 2010 that narrowed its to the promotion of the fine coffee industry, inform focus from eight to four key priorities. It is now directed to all members of all such developments, and facili- areas where there is high constituent demand and where tate joint activities where considered appropriate. AFCA already has a track record of delivery. » Encourage sound business and professional practices. » Enhance consciousness of environmental and social AFCA as partner in policy dialogues as well as socioeconomic issues related to the industry. Whilst AFCA’s value as a promoter of African fine cof- fee is widely acclaimed, there is another equally impor- Until 2007, however, AFCA was entirely donor-funded, tant part to its work, that of influencing sector policy and with an insufficient emphasis on commercial values or regulation where this is in the interests of coffee growers results. A thorough review led to AFCA being rebranded and exporters. As AFCA established a name for itself it and its goal amended to increasing the value and vol- became increasingly possible for it to meet and present ume of African fine coffee exports, and to promoting compelling cases for change to relevant ministries and the domestic consumption of coffee in Africa by improv- other authorities in member countries. AFCA’s approach ing market linkages and building business relationships utilized its unique position in several key respects: through trade conferences. Insider Information To expand market and trade activities, AFCA facilitated Stakeholders in different AFCA member countries member attendance at premier specialty coffee events held would provide data and issues to AFCA to present to worldwide to promote and prominently feature Africa’s coffees. Additionally, AFCA hosted the annual African 26 Visit www.allianceforcoffeeexcellence.org. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 23 their country’s authorities. These stakeholders might presented, and discussed. The forum includes coffee perhaps have feared adverse reactions if they engaged board officials, policymakers from the respective coun- these authorities themselves or could previously have tries, donors, and key coffee experts. The last forum, held failed in discussions with them. Most authorities tend to in Uganda in 2013, reviewed the barriers to regional cof- view AFCA as neutral and working without any particu- fee trading among AFCA countries, and transit issues in lar political agenda and, as a result, are sometimes more the Northern Corridor that runs from Bujumbura, Kigali, receptive to its suggestions than they are to suggestions Kampala, and Nairobi to Mombasa and carries 90 per- from their own industry stakeholders. cent of the coffees from this Great Lakes region. Projection of authority and respect on coffee issues The Impact of AFCA on Coffee Policies AFCA has built a strong brand, and in the countries where AFCA has been instrumental in influencing sector regula- they hold their annual conferences there are many inter- tion or policy in different countries by meeting and pre- actions at the personal level with policymakers and gov- senting compelling cases to the concerned ministries or ernment officials before each event. Most, if not all, have authorities. been appreciative of the fact that these events bring many buyers and coffee professionals to their country and, as a In Kenya and Tanzania, AFCA made the case for rela- result, have become receptive and supportive to sugges- tionship coffee27 and the growth of sustainability and tions on how to improve their coffee industries. certification segments in the market that could not be supported adequately through the Nairobi and Moshi Comparative evidence of better performances auctions. This resulted in what was termed as a “second AFCA would provide empirical data on how other coun- window,” first in Kenya and subsequently in Tanzania. tries were progressing in terms of increased production The direct trade through these windows has grown, espe- and investment, or on matters such as the farmers’ share cially so in Tanzania. in the export price, payment systems, research funding, and so on. Such evidence is usually very compelling and The reform of the Tanzania coffee taxation system powerful in support of AFCA’s advocacy. (2003/04) was heavily influenced by the example of Uganda where taxation amounted to just 1 percent as Easy access to government officials compared to the heavy mixture of district and national AFCA has cultivated easy access to government officials. taxes levied in Tanzania before the reforms, with AFCA In all countries in which they have hosted a conference, facilitating some of the necessary exchanges and provi- AFCA has been able to meet the head of state, as well as sion of comparative data. In another tax-related issue, the the line ministers with whom they usually meet several Democratic Republic of Congo chapter is seeking AFCA times. This is not always the case for the country coffee support to reduce the government coffee tax that now industry players. stands at 15 percent. Coffee board membership The liberalization of the Burundi and Rwanda coffee sec- Most if not all coffee boards from the 11 AFCA mem- tors, as well as the planning of coffee sector reforms in ber countries are paid-up members of AFCA, and a few Tanzania, relied in part on case studies from Uganda, and are represented on the AFCA board. This allows effective benefitted from AFCA’s ability to arrange for delegations engagement on trends in the global market both in the to visit and experience how Uganda managed its own lib- AFCA board and during the annual conferences. eralization exercise. Annual African Coffee Policy Forum AFCA advocacy contributed to the defeat of the so-called AFCA initiated the Africa Coffee Policy Forum, which Tetu project in Kenya that in 2005 proposed to buy all is hosted prior to the AFCA Annual Conference. This forum picks a topical policy or regulatory issue affecting 27 Coffee marketed directly between growers and roasters with a focus on longer regional coffee trade and development that is researched, term collaborative relationships between the sellers and buyers. 24 Risk and Finance in the Coffee Sector Kenyan coffee, roast it, and export it in what amounted to promote itself as a supplier of fine coffees and where no an export and import monopoly. The AFCA Secretariat coffee conference had ever been held before. Similarly, briefed the Kenyan authorities on the dangers posed by there is general acknowledgement that awareness of and this proposal, leading to its ultimate rejection. prices for Mzuzu smallholder coffee from Malawi have both increased substantially since that country first par- Uganda’s coffee research institution was reinstated as an ticipated in an AFCA conference. Other coffee-producing autonomous entity with its own staff and resources purely regions can benefit from this experience, recognizing that because the AFCA Uganda chapter was able to provide only major coffee-producing countries can attract the data on coffee research support from Ethiopia, Kenya, large scale attention and that regional events may raise and Tanzania. These showed the superior level of fund- the profile of smaller coffee nations. ing and human resources that these coffee research insti- tutions had at their disposal when compared with the CASE STUDY 3: FUTURES prevailing arrangements in Uganda. This was despite the fact that Uganda was producing five times more coffee MARKETS IN COFFEE- than either Kenya or Tanzania, but where coffee was just PRODUCING COUNTRIES one of about 36 crops under the purview of a national Overview research institution. This case study examines why, other than in Brazil and despite a number of attempts, to date no viable futures AFCA’s experience demonstrates that the comparative markets for coffee exist in coffee-producing countries. In analysis of different country performances has the most India, despite no less than four attempts (with some ini- impact when the analysis is shared with countries where tially encouraging results), no active coffee futures trad- the coffee sector environment might still require further ing has emerged, basically because the market there is too liberalization and adjustment if it is to respond more small to support it; Indian production of about 5 million adequately to the demands of today’s coffee world. AFCA bags per annum is split between Arabica and Robusta. therefore plans to continue with the policy dialogue agenda Conversely, in Vietnam, production is large enough to by consolidating the interventions that have had the most support a domestic futures exchange, but to date, the two impact to ensure that the African coffee industry as a whole attempts to establish a viable coffee futures contract have becomes more competitive and to boost trade. This can failed to gain traction. happen not only with importing nations abroad, but also between AFCA member countries by promoting regional Interest in developing alternative or domestic futures mar- trade in green coffee as a way of supporting prices. kets in coffee-producing countries appears to be growing, the reason for this growth in interest is not fully under- Conclusion stood, but some industry commentators in part appear AFCA has demonstrated the benefits of marketing, with to suspect that the world’s leading futures markets in the experience in Rwanda probably the most widely- New York (Arabica) and London (Robusta) at times wit- known and obvious example. That country’s coffee indus- ness price movements not fully related to regular supply- try moved from almost total collapse to the point when, in demand type price discovery. The lesson appears to be, 2013, the first-ever “Cup of Excellence” on African soil however, that domestic futures markets for coffee will was held in Kigali. This provided a compelling demonstra- only gain traction if the support base (production) is tion of the country’s emergence from years of turbulence large enough and there is true industry demand; in other to a prominent position as a supplier of specialty coffee, as words, there are enough interested participants to create well as AFCA’s ability to generate the publicity and atten- the necessary liquidity. To date this has not been the case tion that brought a large number of coffee professionals in any coffee-producing country other than Brazil. Addi- and coffee buyers to that event. Similarly, the 2014 AFCA tionally, the regulatory environment has to be supportive, conference brought almost 700 international attendees the integrity of the contract has to be guaranteed, there to Burundi, an equally small country also attempting to has to be a clear link with the physical market, and there A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 25 FIGURE 5.2. BM&F ARABICA FUTURES TURNOVER Millions of 60 kg bags 90 * 2014 1st quarter only 80 70 60 50 40 30 20 10 0 2006 2007 2008 2009 2010 2011 2012 2013 2014* should at least be the opportunity for arbitrage with the coffee mills and warehouses pending final processing, New York and London futures markets. sale, or export (or spot selling as in Ethiopia), leaving the owners exposed to notoriously volatile price fluctuations But even so, whereas a positive enabling and regulatory until sold.28 This scenario again raises the question as to environment in Brazil resulted in a thriving Arabica cof- just why, with the exception of Brazil, there are no func- fee futures contract (for 100 bags), figure 5.2 suggests that tioning futures markets for coffee in any coffee-producing interest has been diminishing. One explanation is that low country.29 As mentioned, only two other countries—India coffee prices and differentials in 2012/13 reduced the allure and Vietnam—have pursued the establishment of such of arbitrage with New York, whereas increasing volatility markets, with little success.30 on the New York Coffee “C” Futures Contract (NYKC) market has caused the arbitrage between the coffee futures Futures Markets in India Coffee Futures Exchange contract of the Bolsa de Valores, Mercadorias & Futuros de of India. Following liberalization of the industry, the São Paulo (BM&F) and NYKC to become more and more Coffee Futures Exchange of India (COFEI) introduced erratic. Additionally, in recent years Brazilian growers have the first coffee futures contract in 1997, trading both extensively diversified their production so that today they Arabica and Robusta. The contract size was 1 MT (Ara- offer substantial volumes of specialty coffee, washed Ara- bica) and 600 kg (Robusta), reflecting the makeup of the bica, and pulped natural Arabica, as well as the traditional Indian producer community, which is predominantly straight naturals. Yet the BM&F futures contract remains smallholder-based.31 At its peak, COFEI recorded trades based on naturals type 4/5 or better, good cup or better. of 77,036 contracts or almost 50,000 MT in 2000 (see Type 4/5 naturals refer to a grade of coffee that underlies figure 5.3). Interest subsequently dwindled, mostly as a an exchange traded contract. result of the coffee crisis when speculators lost heavily and growers also exited the market amid steep price declines. Background. Case Study 14, “Warehouse Receipt Sys- tems (WRS) in the Coffee Sector,” illustrates that without 28 The study also noted that collateral management is the most prevalent form an option to sell forward, holders of such receipts remain of secured lending in the coffee trade. 29 Brazil: BMF-Bovespa: http://www.bmfbovespa.com.br/en-us/markets/ fully exposed to price risk. Yet the introduction of WRS commodities-and-futures/commodities-and-futures.aspx?idioma=en-us. in a number of countries was mainly intended to facili- 30 There are two leading futures markets in the world: New York for Arabica (The tate access to finance that in turn would avoid forced early InterContinental Exchange [ICE] www.theice.com) and London for Robusta season selling by farmers when prices are low. As the case (https://globalderivatives.nyx.com/nyse-liffe). ICE controls both markets. 31 India has a number of actively trading commodity and metals exchanges, study noted, however, in the coffee sector, warehouse and all come under the ambit of the Forwards Markets Commission (FMC) receipts are almost exclusively used to finance already of India, which is itself under the Ministry of Finance. The FMC regulates all aggregated semi-processed coffee that is stored in licensed aspects of futures trading and settlement. 26 Risk and Finance in the Coffee Sector FIGURE 5.3. TURNOVER (IN MTs)—COFFEE both small and large investors who help provide the neces- FUTURES EXCHANGE INDIA sary liquidity. This makes the failure of the coffee market 60,000 all the more puzzling, although some explanations have 40,000 been suggested. 20,000 0 1998 1999 2000 2001 Successful soft commodity contracts in India represent essential commodities that are produced and consumed in large quantities by the Indian population. Not only does Trading finally ceased altogether on August 31, 2005, and the general population know these commodities well, but COFEI was liquidated. there is also a strong link with the physical or spot market because such commodities are physically traded daily in National Commodity and Derivative Exchange designated market places known as mandi. (NCDEX). The National Commodity and Derivative Exchange introduced a 2 MT Robusta futures contract in By contrast, coffee is less prominent in what is predomi- April 2005, with trading hours to coincide with the London nantly tea-drinking culture, and is traded only among a lim- Robusta closing time. Interest was limited, causing the con- ited group of stakeholders (mainly in the south of India). tract to be relaunched in September 2007, but it did not gain The lack of a large domestic market makes establishment traction and was finally withdrawn altogether in mid-2008. of a successful, liquid futures contract difficult. If the market lacks operators who are interested in taking physical deliv- The Multi-Commodity Exchange introduced a 1 MT ery, for example domestic roasters, then over time the link Robusta futures contract in January 2007 that initially with the physical or cash market becomes tenuous at best. attracted strong speculative interest, with 128,319 contracts traded during the first three months of operations. Once In general, futures prices for mainstream commodities speculators realized that the potential returns were mea- traded on the Indian commodity exchanges relate to ger compared to other commodities, turnover fell sharply. Indian fundamentals; that is, supply and demand and the From November 2007 onwards, trading was in single digits, weather (particularly the monsoon). As a result, spot and causing the contract to be abandoned later in 2008. futures prices for mainstream commodities in India are closely related, but this is not the case for coffee because The National Multi-Commodity Exchange (NMCE) the quality of most Indian graded Robusta and Arabica launched both Arabica and Robusta futures contracts in for both export and domestic consumption is much higher early 2005, but poor levels of participation soon caused than what is represented by both the domestic and the Lon- the Arabica contract to be halted, with only limited trading don and New York futures markets. Nevertheless, Indian continuing in Robusta. The Robusta contract (1.5 MT) was coffee futures rely for direction mostly on price movements relaunched in October 2007 with extended trading hours. on the two international markets, even though quality and Today, NMCE is the only Indian exchange to still trade domestic prices in India are much higher. As a result, for Robusta futures, although recent turnover figures have Indian coffee, particularly Robusta, there is no real link been uneven: 38,220 lots or 57,330 MT in 2012; 24,245 between futures and physicals, and this undermines the lots or 36,376 MT in 2013; and 10,615 lots or 15,922 MT entire strategy of tendering physicals against futures.33 as of March 10, 2014.32 Accordingly, while physical delivery of coffee against futures Discussion. Indian commodity exchanges (softs and has always been possible, it was little used mainly because especially precious metals) are very successful and active thanks to both excellent organization and a large pool of 33 Of course prices for commodities as cotton, edible oils, sugar, and soya are to a certain extent also influenced by international price movements, but not 32 As per FMC regulations, the NMCE website (www.nmce.com) also shows a as much as the locally-produced and consumed pepper, copra (dried coconut), spot price for Arabica, but this is for information purposes only; no trade or guar gum, guar seeds, cardamom, mustard seed, castor seed, barley, potatoes, delivery takes place. turmeric, chilies, coriander, cumin, and so on. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 27 there were so few parties interested in taking delivery, with annual Indian production of around 5 million bags is split most (especially speculators) preferring settlement instead. between about one-third Arabica and two-thirds Robusta, The few physical deliveries that have taken place often the Indian coffee sector is in fact too small to support a resulted in quality disputes because, perhaps not unsurpris- viable domestic futures contract. ingly, the tendered quality did not suit the purposes of the recipient, only further discouraging potential interest. Warehouse Receipts in India. While, at least in part, insufficient education and information played a role in the In the absence of correlation between the physical product failure of coffee futures trading to gain traction and the and the futures market, there is little point in using such contracts failed to take hold, the work of the exchanges a market for hedging purposes, as the two show differ- nevertheless benefited the coffee sector. The establishment ent price levels and may also move in opposite directions. of a coffee futures contract requires a systematic approach Hedging, however, assumes the two prices will eventually that ensures that all of the prerequisites for a successful converge or at least move more or less in tandem. With- contract are put in place, including the availability of a out hedgers, a futures market comes to rely on speculative reliable deposit and delivery certification system, collat- activity alone, which is unsustainable; over time all come eral management, and the involvement of commercial to share the same view; that is, all want to buy or, all want banks. These services obviously offer real value to a com- to sell. As a result, volumes fall and liquidity is lost. modity sector even without an exchange in place. In this respect NCDEX did establish a fully-fledged collateral As demonstrated by the vibrancy (liquidity) of other management scheme in 2004 through a company called commodities on the Indian futures markets, it is clear National Collateral Services Ltd. (NCMSL). that actively-traded commodities and the links between futures contracts and physicals are well understood, and NCMSL no longer deals with coffee as such, but today prices in the physical spot market reflect prices on the provides services for a range of 42 different commodi- exchange (showing a domestic demand for such commod- ties including soya, wheat, sugar, and so forth through ities). However, this is clearly not the case for the domestic 486 warehouses spread over 131 locations, and provides coffee market, where fundamental information is sparse formal collateral management services for some 14 major and there is no obvious link between futures and spots, commercial banks. In addition, warehouse receipts are resulting in limited interest and low liquidity for the cof- widely issued against physical stocks (under The Ware- fee futures contracts available on Indian exchanges. Low housing Development and Regulation Act) that are liquidity always poses risks for holders of open positions negotiable instruments of title. These can be pledged as because, as mentioned, when all or most participants have collateral, traded, and transferred and can be used as ten- the same objective, it becomes impossible to quickly close der against an open futures position. This confirms the out a position. The strength of liquid futures markets is role commodity exchanges can play in developing ware- that one can always and immediately buy or sell thanks to house receipt systems.35 the continuing presence of market makers, traders, and speculators. Where this is not the case, the market has Futures Markets in Vietnam. The Buon Ma Thuot no real value as a hedging platform because one cannot Coffee Exchange Center (BCEC) in Dak Lak com- “lift” a hedge when required.34 In any case, given that the menced operating in 2008 as a spot market for physical coffee, which would be warehoused and inspected by the 34 For example, an exporter sells physical coffee forward to an overseas buyer, exchange prior to sale. The aim was to provide a transpar- coffee that the exporter does not yet have and that it must buy later in the sea- ent market system that allowed farmers and collectors to son. To mitigate the risk that prices might rise before it can purchase coffee, the access all available pricing information and so negotiate exporter hedges it by simultaneously buying an equivalent amount of coffee better prices, whereas buyers would be assured of both futures. When it comes to buying the physical coffee to fulfill the forward con- tract, the exporter must be able to lift the hedge (that is, sell the futures) simul- taneously. If this is not possible because of an absence of buyers for the futures, then not only is the futures market of no use as a means of hedging one’s risk, 35 Other collateral managers include NBHC, Arya Collateral, Geo-Chem, and but the exporter might incur a substantial loss as well. Star Agri. 28 Risk and Finance in the Coffee Sector quality and contract integrity. BCEC partnered with a fully-fledged commodity derivatives exchange in 2010, settlement bank, an independent quality control agency, and it commenced offering a 5 MT Robusta futures con- and a warehouse operator (which was itself active in coffee tract in 2011. It was expected that linking the contract trading and exporting). This approach initially appeared to both the London Robusta market and the Singapore successful, with turnover of some 20,000 MT in its first Commodity Exchange (SICOM) Exchange in Singa- year. However, the turnover was probably assisted by the pore would encourage participation (by providing two fact that the settlement bank also offered warehouse receipt separate quality specifications). This link should have financing for up to 70 percent of the value of the underly- assisted liquidity in that VNX could offset contracts on ing goods. Even so, interest soon dwindled when it turned either of these exchanges should local liquidity be insuf- out that against many sellers there really was only a single ficient. Exchange-licensed warehouses would store cof- buyer—the company running the warehousing function. fee to be tendered, and the objective was to arrange for As a result, the spot contract lost traction with farmers who grading to take place at the London exchange, eventu- seemingly objected to having to deliver to coffee ware- ally leading to LIFFE-certified coffee being available ex- houses in Buon Ma Thuot that were controlled by a single warehouse Ho Chi Minh City.37 This arrangement was buyer; the growers preferred to sell to more easily acces- expected to assist stockholders in raising finance against sible collectors instead. Some may also have been under such London-graded stocks and so further increase the impression they would receive a subpar price because liquidity on VNX. Sadly, VNX seemed to be ahead of the market position of the warehousing company. It of its time; the necessary legislation to facilitate such would also seem likely that other exporters would object arrangements with outside partners, such as the London to having their purchases handled by a competitor. Dur- exchange, was not yet in place. Additionally, there was ing 2012, turnover fell to just 137 MT which, incidentally, no in-house coffee trade experience at the exchange, also led to the dissolution of the warehousing partnership. leading to an absence of understanding of market fun- As a result, there was no turnover whatsoever in 2013.36 damentals and dynamics. Moreover, the potential client However, through a new partnership with Ho Chi Minh target group of large producers, traders, and export- Development Bank, BCEC is now finally able to offer a ers was in any case directly or indirectly active on the fully independent warehousing package that appears to LIFFE market already. In any event, none of the pro- have rekindled interest in the spot trading service with a posed arrangements materialized, and by 2013, VNX turnover of 3,200 MT in the first quarter of 2014. had closed down entirely. As early as 2011, BCEC had also received regulatory Discussion. In contrast with the experience in India, the authorization to add futures trading and started offering export price for the Vietnamese Robusta market is directly a 2 MT contract designed to enable individual farmers linked to the London futures market, with individual to take part. This has failed to gain traction, however, in growers actively monitoring price developments through large part because BCEC has been unable to attract out- mobile phones, tablet computers, and the like.38 Given side partners with the requisite expertise to help develop this, any Vietnamese domestic futures market should be the futures trading side of its business. Impending govern- linked to the London market in some fashion and should ment regulations are expected to facilitate such partner- offer opportunities for arbitrage between the two to pro- ships. To date, most of the small turnover has come from mote interest as, for example, can be done between the market makers themselves. Brazilian and New York Arabica exchanges.39 In theory, Vietnam, with an annual production well in excess of The Vietnam Commodity Exchange (VNX) in Ho Chi Minh City was established as Vietnam’s first 37 Ho Chi Minh City is Vietnam’s main coffee export port. 38 Prices for physicals are closely related to developments on the London market, and given Vietnam’s importance as a supplier, this cuts both ways, with differen- 36 The longer-term intention was always that BCEC should invest in its own tials narrowing or widening depending on Vietnamese domestic fundamentals. warehousing and processing facilities, enabling it to offer a full range of services 39 In this context, arbitrage means trading the difference between two markets in to farmers, but this never materialized. the belief that the value of one is over- or under-stated compared with the other. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 29 1 million MT, should be able to support a viable coffee Exchanges trade a standard, average product based futures exchange, if there is sufficient liquidity. There has on a requirement that the quality of coffee tendered to be interest from both sellers and buyers (including pro- has to conform to a standard specification. As domes- ducers, collectors, exporters, domestic roasters, and inves- tic demand in Vietnam is still small compared to total tors and speculative traders); if only sellers or only buyers production, it would seem likely that most tenders appear, then trading becomes impossible. This essentially (physical deliveries against futures contracts that are led to the demise of three of the four Indian coffee con- not offset) would end up with exporters. However, tract initiatives. Additionally, there also should be links except for truly unusual circumstances, it seems unlikely with the physical market in that there have to be parties major exporters would take delivery of exchange- who are interested to receive or deliver actual coffee. In graded coffee to fill export contracts. Not only do contrast to Brazil, current domestic demand in Vietnam is such contracts have their own quality stipulations, but far too small to be a factor and it seems unlikely that other increasingly final buyers also require traceability back parties, locally or abroad, are really interested in taking to the producer under whatever sustainability standard delivery through a domestic exchange. The same is true that they subscribe to. This suggests that general inter- for India’s sole surviving coffee futures contract, where a est in taking physical delivery could remain limited to lack of interest in taking physical delivery has starved the domestic roasters and internal traders, which again market of liquidity. emphasizes the need for some form of linkage with the London futures market; otherwise there will be a As with any market, futures contracts for coffee in Viet- risk of domestic coffee futures becoming disconnected nam will only gain traction once there is real industry from the physical market.41 demand to provide the necessary market liquidity, which, to date, has not been the case.40 That said, other factors The Requirements for Establishing a Sustainable could also play a role in promoting such a market: and Liquid Derivatives Market42 » The regulatory environment has to be supportive, not only in terms of attracting experienced and Purpose. The primary purpose of derivative contracts financially strong partners, but also in terms of is the ability they provide to participants in the commod- recognizing that there has to be at least the op- ity value chain to mitigate price risk on both the sell and portunity for arbitrage with the London futures buy sides on an economic basis. It is imperative that the market. establishment and operation of a futures market is funda- » There has to be an appropriate operating environ- mentally based on this objective. It is also important that ment; in other words, the integrity of all contracts the aim of a futures market is not only understood but is guaranteed by a well-resourced clearinghouse, also shared by all participants in the industry, particularly and there is adequate independent supervision. by policymakers. » The status in law of both the public warehouse operators and the negotiable warehouse receipts Policy. A supportive policy environment would include they issue for exchange-graded coffee is clear and a national regulator to oversee a smooth-functioning unambiguous. market and a commodity policy that is conducive to the operation of the free market without interference from However, this still leaves unresolved the question of the government or its agencies in the market mechanisms quality of physical deliveries and who would be interested in taking delivery. 41 For the 2013 crop year, the ICO estimated total Vietnamese production at 27.5 million 60 kilo bags and domestic consumption of about 1.5 million bags. Major domestic roasters mostly procure their own coffee directly from farmers, collectors, and traders. 40 Experience with, for example, gold futures trading in 2008 suggests there is no 42 Requirements derived from: “Guidebook on African Commodity and Deriva- shortage of purely speculative interest in the Vietnamese economy, but whether tive Exchanges” from the African Development Bank (2013); and “The Coffee coffee would attract the same interest of course remains to be seen. Exporter’s Guide” (International Trade Center 2012). 30 Risk and Finance in the Coffee Sector that influence the price and trade flow of the prod- ucts. The rules and directives of the market operator CASE STUDY 4: together with those of the central clearinghouse must be IMPLEMENTING PRICE clear, concise, and consistently applied across all market RISK MANAGEMENT IN THE operations. RWANDESE MARKETPLACE Issues Participation. Active participation in the futures mar- The goal was to protect producer organizations or coop- ket by both buyers and sellers not only delivers liquidity eratives that operate coffee wet mills against potential loss and cost efficiency, but also builds integrity in the market. or default due to major price moves, and create access to Participation should not be forced by legislation, although hedging opportunities. incentives could be encouraged. However, participation should be the natural result of the value-add that the mar- Response ket offers the participants. In addition, participation can Technoserve, an international nonprofit organization, benefit from significant effort in the capacity building of works with exporters buying from producer coopera- both buyers and sellers. tives that own coffee wet mill stations, providing ser- vices that help reduce or avoid the losses and defaults A functioning futures market also requires the participa- that can arise from sharp movements in both local and tion of speculators who are prepared to take on the risk global coffee prices. The scheme is innovative in its use of others in the hope of earning a return. Speculation of cell phone technology to track the daily volume of is a necessary part of futures markets, as it allows hedg- coffee cherry purchases, the volume of coffee parch- ers to enter and exit the market quickly and easily when ment yielded by the coffee washing process, coffee stock required. movements, and wet mill station operating expense data. Product. The product specifications of the contracts This data keeps exporters informed of how much coffee should be based on and reflect the physical spot product is being held at the stations they buy from, and allows flow. Although the volume of trade flow is certainly an them to use this volume data on the futures market to important factor in the success and liquidity of a deriva- lock in a price. The program was initiated in 2010 and tive market, it is essential to have a well-designed contract by 2012, approximately 1,000 MT had been hedged on that closely reflects physical trade and that facilitates well- the New York futures market.43 correlated hedging. Background Rwanda’s coffee sector has similarities to many other Conclusion. To date, no exchange in Vietnam has ful- coffee-producing countries. Farmer associations and filled all of the necessary prerequisites for establishing cooperatives buy coffee cherry from smallholder coffee a sustainable and liquid derivatives market, hampering farmers, process it at their wet mill station, and subse- trade in domestic coffee futures. However, given the size quently sell that coffee to exporters. The exporters then of Vietnam’s production and the number of participants mill, market, and ship green coffee to buyers across the in its coffee sector, it seems likely some form of domes- globe. Many exporters are subsidiaries of global trad- tic Robusta futures trading could attract sufficient inter- ing houses, with some domestic exporters active as well. est, provided the rules encourage maximum access, offer When purchasing coffee, exporters and buyers reference protection for international participants and investors, the international market price when determining their and the physical delivery process is both functional and offer price. dependable. In India, production is too small and frag- mented between Arabica and Robusta to generate the 43 Rwanda produces Arabica, a small percentage of which is processed in necessary interest and liquidity, even though existing modern wet mill stations. The 1,000 MT that was hedged represented about infrastructure and regulation offer undoubted potential 25 percent of the total 2012 wet mill station output of some 4,000 MT. The for a domestic coffee futures contract. bulk of Rwandan coffee output is processed using conventional means. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 31 As with any other market, a challenge for the Rwandese resources to effectively utilize these markets. With hedging coffee market is that sharp price movements can occur in nevertheless representing the best approach against price relatively short periods of time. As a result, coffee harvested volatility, the question remained: How could produce when the market is strong could be sold at a point when organizations benefit from such strategies? the market has collapsed, adversely impacting the position of cooperatives and their member farmers. As an example, Providing Price Risk Management to Producer after a significant period of rising prices in 2010, the inter- Cooperatives national price of coffee started to fall dramatically in 2011. As described above, the cooperatives in Rwanda had Cooperatives in Rwanda suddenly found their profits wiped been struggling with the adverse effects of volatile prices. out, with some at risk of making losses. The risk of default They neither had the expertise, the financial resources, became quite real, and answers had to be found to avoid nor the access to markets to enable them to directly man- similar occurrences in the future. To avoid such exposure age their exposure to such price volatility. By working with to price fluctuations, cooperatives could consider agreeing a Technoserve (which had helped to establish relationships price with a buyer for an entire season (in other words, for- between these producer cooperatives and coffee exporter ward selling), allowing them to know exactly what price to companies), producer organizations were able to benefit expect once their coffee is harvested and processed. How- from a hedging strategy implemented by coffee exporter ever, despite the benefit of price stability, such agreements companies. In Rwanda, in addition to milling and market- (informal or contractually bound) are also exposed to their ing services, coffee exporters also provide working capital own risks. In particular, should prices fall during the season, financing to the producer organizations. Working at first a buyer might try to renegotiate a contract to obtain more with one local exporter, Technoserve began a program to favorable terms. Conversely, should prices rise, farmers better enable that exporter to manage the price risk of might not sell their coffee cherry to the cooperative, choos- coffee purchases by utilizing the coffee futures market. ing instead to sell to a competitor paying a higher price. The mechanism included an exporter paying a coopera- Hedging as a Solution tive a price determined by the current international cof- Price risk is an issue for all actors operating within an agri- fee market at the time the purchase was negotiated. The cultural commodity supply chain. Commodity exchanges exporter would, in turn, hedge the volume of coffee it or futures markets provide access to futures contracts that purchased through a sale on the futures market, therefore can be used to manage and protect against price risk. The locking in its own price and justifying the price agreed coffee futures contract traded on the New York exchange with and paid to the cooperative. As such, all parties in the represents the global market for Arabica coffee. This mar- transaction would no longer be exposed to price fluctua- ket allows coffee sector firms to both buy and sell coffee for a tions, minimizing future default risk. future date, protecting themselves against price movements caused by their position in the physical coffee market.44 In order to execute on such a strategy, the exporter required accurate, daily coffee volume information regarding daily For producer organizations and cooperatives, accessing the cherry purchases at the cooperative level as well as how futures market is a challenge logistically (connectivity with much green coffee that cherry could be expected to yield. markets), financially (the need to have sufficient funds to By knowing how much coffee the cooperatives had pur- cover hedges and meet margin calls), and in terms of com- chased daily, the exporter could use pooled information plexity (the risk of increasing rather than reducing risk if from its member cooperatives to hedge its exposure and a hedging strategy is poorly implemented and managed). reduce price volatility risks. As such, the vast majority of trading on the exchanges is by coffee exporters and buyers rather than by producer Challenges of Hedging via an Exporter Service organizations. Such enterprises have the in-house skills and Provider This approach is not without its own challenges. Specifi- 44 The physical market is where the actual green coffee changes hands. cally, exporters provide marketing services to many farm 32 Risk and Finance in the Coffee Sector cooperatives at once and require accurate, daily coffee relatively simple to use, sparing the need for expensive cherry purchase volume reports from each of these rural training. Finally, data sent via SMS is both inexpensive businesses in order to hedge. Additionally, exporters pro- and fast. SMS data can arrive almost instantly rather than vide credit services to many cooperatives and need to be delayed by conventional postage. In short, this pro- oversee these loans. The most effective way to do this is gram utilizes existing, readily available, and easy-to-use to monitor the farm-gate prices paid daily by cooperatives technology, enabling speedy adoption, rapid expansion, to farmers for the cherry they deliver to the wet mill stations and reduced user error. and to ensure that these prices are in line with what the international market would justify. With an accurate moni- How the System Works toring tool, exporters can ensure cooperatives do not over- SMS bookkeeping requires wet mill station accountants to pay for coffee cherry, thereby risking a loss at the time of send daily and weekly messages that are recorded on an sale and defaulting on loans. If exporters were geographi- online platform that is accessible to affiliated lenders and cally near to their member cooperatives, they could more export companies. The daily message reports the kilos of easily monitor these businesses closely; however, most wet cherry purchased, the cash or credit spent on cherry, and mill stations are rural, located far from where the exporters the cash advanced to satellite buying sites. The weekly cash are based. As such, a more transparent inventory manage- message contains opening cash balances, working capital ment system was needed to allow exporters to obtain accu- received, and operating expenses at each cost center. A rate pricing and stock volume information from rural wet weekly stock message includes data on parchment moved to mill stations in order to execute on their hedging strategy, storage from the drying beds, and the parchment shipped as well as for their loan monitoring purposes. to the dry mill. The cloud-based system collates this infor- mation from all wet mill stations, allowing an exporter to Traditionally, cooperatives have used paper-based records view its entire portfolio of wet mill stations at once. to monitor volume and operating expense information. But paper-based records are difficult to share and easy to falsify, With this information, an exporter at any point can causing delays in information dissemination and difficul- know exactly what the stock position of each wet mill ties in monitoring for fraud, theft, or poor management. station is; where coffee sits in the chain; and the pric- ing and cash position of each wet mill station, providing A More Transparent Inventory Management them with sufficient information to ensure that funds are System Solution being spent appropriately and to know when they should Technoserve worked closely with Rwandese exporters and hedge the exposure. The system promotes financial cooperatives to find a solution to these issues. As a result, a transparency but also protects private information. Pro- short message service (SMS) bookkeeping tool was devel- ducer organizations, exporters, and other related parties oped, linking simple cell phone text message technology to agree on the data that will be viewable to each party a sophisticated cloud-based platform. The move to SMS at the beginning of the beginning of the season. The bookkeeping enabled daily data collection at wet mill sta- system also can be programmed to send performance tions that could then be shared in real time with exporters, reports to cooperative leaders and farmers directly via enabling them to use this volume data to hedge coffee at SMS, thereby promoting financial transparency within appropriate scale and times and monitor the risk associ- producer associations. ated with lending working capital to these cooperatives. Improving Access to Finance The benefits of using cell phones and SMS technology The program and the inventory management system ena- are widely recognized: Cell phone usage is extremely bled cooperatives and their smallholder farmer members widespread in Rwanda, including among wet mill station to benefit from a sophisticated hedging strategy, thereby accountants. Taking advantage of existing technology avoiding price risk and related losses. Exporters, in their removed the need for expensive or complicated hard- role as credit providers, are able to underwrite greater ware (such as computers). Additionally, these phones are amounts of working capital to the producer organizations A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 33 as well as disburse them more timely and efficiently TABLE 5.2. SEASONAL PRICE VOLATILITY thanks to the availability of real-time information and the Harvest Start End Variation resulting improvement in the performance of producer 2011/12 290 186 −/− 35.8% organizations. This has caused an increase in financing available to producer cooperatives at a time when many 2012/13 165 136 −/− 17.5% businesses and banks continue to be hesitant to extend 2013/14 115 185 + 60.8% loans to small, rural, agriculture-based borrowers. How- ever, while significant improvements have been achieved with cooperatives made more stable and accessing addi- Taking sales decisions in this environment is not only dif- tional funding, farmers still face price risk with periods ficult, but can also be quite hazardous. Even where a of lower prices adversely reducing their incomes. At the guaranteed floor price, such as provided by the Fairtrade end of 2012, SMS bookkeeping had been implemented model, is in place, volatility still impacts on the decision- at more than 50 of Rwanda’s 215 cooperatives. Begin- making process, as not all of a cooperative’s production ning with the next coffee season (2013), TechnoServe is necessarily traded under Fairtrade conditions. Realiz- will begin implementing this approach in Tanzania and ing that poor decision-making processes were detracting Ethiopia. from an efficient and sustainable supply chain, in 2009 the U.S. firm Sustainable Harvest Specialty Importers, based in Portland, Oregon, created an extended program CASE STUDY 5: MINIMIZING to improve financial literacy and market insight and to PRICE RISK THROUGH promote price risk management. Today, 41 cooperatives VARIABLE SALES USING CALL have joined up, including 27 in Peru and 14 across Cen- OPTIONS45 tral America (Costa Rica, Guatemala, Honduras, Mex- ico, and Nicaragua).46 The need for such an approach has Cooperatives that sell coffee forward on a fixed price basis again been highlighted by the extreme volatility of the run the risk that subsequent price rises will cause their New York C Contract during the last three harvest sea- members to default and side-sell instead. Selling forward sons in Latin and Central America, as shown in table 5.2. on a price-to-be-fixed (PTBF) basis and fixing the sales price at the time coffee is bought excludes most (if not Financial literacy, audited accounts, and an ability to all) price risk, as the two transactions (buying green cof- demonstrate value-added are all prerequisites for any fee and fixing the PTBF sale) are literally back-to-back. business case for all types of commercial enterprise in all In both instances, however, buying a call option ensures types of industries and sectors.47 In terms of accessing a cooperative can still benefit from subsequent price rises finance, having confirmed sales on the books to preap- should they occur, the cost being an integral part of man- proved buyers makes it easier to obtain seasonal funding aging price risk. The choice as to whether to buy options to finance coffee purchases. All 41 cooperatives taking is therefore a strategic decision. part in the Sustainable Harvest program had previously demonstrated their reliability as suppliers, both in terms Background. Price volatility complicates the timing of coffee quality and respect for contract execution, but of marketing decisions for the entire supply chain, par- ticularly for managers of coffee cooperatives who take sales and pricing decisions on behalf of their members. If prices rise subsequent to sale, then the members may 46 Partly funded by grants from USAID and other donors. Total cost circa refuse to supply (default); conversely, if prices fall subse- US$1,000 per participating cooperative who also make a small contributions themselves to ensure solid buy-in. quent to buying coffee, then a cooperative will lose money. 47 Without financial literacy, a cooperative may not know its true costs (and can- not present a good business case to potential lenders), whereas a lack of market insight may result in blind speculation or indecision. While trading back-to- With thanks to Sustainable Harvest Coffee Importers, Portland, Oregon, 45 back (buy and sell simultaneously) sounds simple in terms of risk avoidance, in USA. reality this does not really make the pricing decision any easier. 34 Risk and Finance in the Coffee Sector all had difficulty in coping with the complexities of taking can also be made under Fairtrade conditions, in which case pricing decisions, including how to manage PTBF sales.48 the seller will still receive the guaranteed Fairtrade floor price if the market falls and the contract remains open. In addition to promoting broad financial literacy and financial discipline, the Sustainable Harvest program con- The Problem. When physical coffee is received, a coop- sists of ongoing (and annual refresher) training encom- erative should either sell it outright or fix an outstanding passing the functioning of markets, market analysis, the PTBF contract; if it does neither, it is engaging in specu- role of futures, using put and call options, and related sub- lation. However, decision making is complicated by the jects such as daily position analysis. Initially, a total of four prospect that the seller can forego potential profits if the training seminars were held. Participating cooperatives market rises subsequent to selling or fixing a price. In the subscribed to independent real-time price information case of preseason forward sales at outright or fixed prices, through an account established by Sustainable Harvest, such subsequent price rises may even lead to members and were charged a minimal fee. defaulting by refusing to deliver coffee and side-selling it instead, knowing their cooperative cannot match the spot To understand the nature of price risk facing those in the market price at the time the member’s coffee is ready. coffee sector, it is helpful to review the two sales methods When prices are near the guaranteed Fairtrade floor it employs: price, some cooperatives may decide not to fix, as they are » Outright sale: In addition to all usual terms and covered as long as the contracts in question are Fairtrade- conditions, the contract immediately stipulates the based. But for many cooperatives, Fairtrade sales only final price. account for part of their total turnover. » Sale PTBF: Seller and buyer agree quality, quantity, delivery, and the differential against which futures The Answer: Variable Sales Using Price Insur- position the sale is to be fixed. The sale is “sellers ance. Participating cooperatives can purchase call options call” in that the seller calls for the fix (within the (the right to buy coffee futures forward at a set price) at time period and in the manner agreed). The seller the same time they sell physical coffee outright or fix an is not involved in any futures transactions but sim- existing PTBF contract, utilizing a Sustainable Harvest- ply calls for the price to be fixed using the method sponsored account. This combination of fixed price and laid down in the contract.49 call option is called a variable sale, as the net result can still vary even after the sales price has been fixed; if, for exam- The pricing decision is made immediately in the case of ple, the futures market rises, so will the value of the call the outright option, and is postponed under PTBF. Accord- option. On expiry, the option will then be cashed in and ingly, cooperatives need to have clear internal guidelines the profit, minus the option cost, will accrue to the coop- that govern the fixing of PTBF contracts. PTBF contracts erative. Should the market fall, then the option is simply allowed to expire and the cost (the “insurance premium” 48 In terms of supply and demand, producers need to confirm sales for their that was paid to benefit from a possible price rise after production and roasters need to fill their supply line, but neither may neces- sale) will be drawn from the original sales transaction.50 sarily wish to set the price at the same time as they make those arrangements. Selling or buying green coffee at a defined differential to the futures market While the notion of buying protection against price rises (called Price To Be Fixed [PTBF]) leaves the final price decision until later, yet may seem strange to some, the validity of this approach accommodates these conflicting interests. At the same time, outright or price risk is changed into differential or basis risk. Basis risk is usually much lower than price risk. Nevertheless, also such sales still require pricing decisions in that someone has to decide when to “fix” the futures price that, together with the 50 Options can be traded daily, meaning the buyers alone decide whether or not agreed differential, will constitute the final sales price. In the mainstream cof- to hold them until expiry or to sell them earlier. The cost of options varies and fee trade the “fixing” of PTBF is often done through the buying and selling of individual cooperatives decide whether they consider the premium worthwhile. futures contracts, something that may producers may find complicated. But this Clearly, calls are cheaper in a falling market. Cooperatives seeking protection is not the case under the Sustainable Harvest approach. against falling markets can purchase put options (the right to sell coffee futures 49 With the Sustainable Harvest system, the cooperatives need not concern forward at a set price), but this is not part of the Sustainable Harvest program, themselves with futures transactions. as it does not relate to the import of physical coffee. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 35 TABLE 5.3. OUTCOME FROM CALL OPTIONS UTILIZED BY NICARAGUAN COOPERATIVE 2013/14 SEASON Contract Cost Call Liquidation Value Issuance Shipment Fixed Price Option Date Weight lb Recovered/lb November March 2.05 4,481.25 2/4/2014 42,600.00 0.11 November February 2.05 7,500.00 2/18/2014 42,600.00 0.18 December February 1.75 5,043.75 2/5/2014 42,600.00 0.12 December February 1.75 5,043.75 2/5/2014 42,600.00 0.12 December March 1.75 4,031.25 2/6/2014 42,600.00 0.09 December March 1.75 4,031.25 2/6/2014 42,600.00 0.09 December March 1.75 4,968.75 2/6/2014 42,600.00 0.12 December April 1.75 7,293.75 2/14/2014 42,600.00 0.17 December April 1.75 7,293.75 2/14/2014 42,600.00 0.17 December April 1.75 7,293.75 2/14/2014 42,600.00 0.17 December May 1.75 27,937.50 3/7/2014 42,600.00 0.66 December May 1.75 27,937.50 3/7/2014 42,600.00 0.66 December February 1.75 5,043.75 2/5/2014 42,600.00 0.12 Average 0.21 for cooperatives or other types of farmer organizations or when fears of frost in Brazil come into play. When who market coffee on behalf of their members has once prices are very low, as seen in 2013, Fairtrade accredited again been amply confirmed by the price movements in cooperatives tend to rely on the guaranteed minimum the 2013/14 season. Table 5.3 shows the actual outcome price, but this is not always possible if their total volume for a cooperative in Nicaragua that purchased call options exceeds their Fairtrade sales opportunities. during the 2013/14 season.51 Given the uncertainty surrounding the availability of Outcome. The cost of call options was subsidized by Brazilian coffee mid-2014, most of the participating 50 percent in Years 1 and 2 for all participants, but some cooperatives intended to market their 2014 harvest using now pay the entire cost alone. There are also instances PTBF contracts and to buy call options when fixing. Fix- of buyers paying the entire cost. The average cost of ing when buying coffee at market price excludes most if call options purchased to date has been US$1,317 each. not all price risk, as the transactions are literally back-to- The proportion of sales that result in the purchase of call back. Buying the call option ensures they can still benefit options varies considerably depending on market condi- from subsequent price rises should these occur, the cost tions. Generally, most interest arises at the beginning and being an integral part of their price risk management end of the season when the price outlook may be less clear strategy (figure 5.4). Today, participating cooperatives know their cost price. 51 Exercising options: The holders monitor both futures and the option value They understand market behavior and mechanisms bet- through the Sustainable Harvest sponsored account. Options showing profit ter, their decision-making processes have been formal- can be exercised through direct orders to the broker by giving a “good-till- ized, and they have learned how to make use of market called” order (the broker sells when the stated value is reached); or by stop-loss orders (the broker sells automatically if the value of a profitable option falls to rallies to transact both physical coffee and options. They a certain level). now use both fixed-price and PTBF contracts and do not 36 Risk and Finance in the Coffee Sector FIGURE 5.4. THREE SEASONS AND THE RELATIONSHIP BETWEEN PRICE AND FAIRTRADE MINIMUM PRICE CROP 2011/2012 350 First position FTMP ICE C-USD/Qq 300 250 200 150 100 9/1/2011 10/1/2011 11/1/2011 12/1/2011 1/1/2012 2/1/2012 3/1/2012 4/1/2012 First position FTMP CROP 2012/2013 190 180 ICE C-USD/Qq 170 160 150 140 130 120 110 100 9/4/2012 10/4/2012 11/4/2012 12/4/2012 1/4/2013 2/4/2013 3/4/2013 4/4/2013 First position CROP 2013/2014 220 FTMP ICE C-USD/Qq 200 180 160 140 120 100 9/17/2013 10/17/2013 11/17/2013 12/17/2013 1/17/2014 2/17/2014 3/17/2014 Source: The Intercontinental Exchange website: https://www.theice.com/index. necessarily fix entire positions all at once, but judge mar- the borrower. Variable sales therefore present an accept- ket behavior. Improved monitoring, trading, and risk man- able compromise that lenders should consider and, where agement has provided some of them not only with more required, they could assist with funding of the cost of call but also with cheaper finance as lenders understand better options.52 how this system functions and the assurances it provides. On average, the result for PTBF contracts combined with Lessons Learned call options has been better because the cooperatives fixed Major lessons of the Sustainable Harvest program are the price as soon as they had the physical coffee, knowing the importance of having insights on both sides of the the call option gave them a stake in any subsequent mar- relationship (producer and roaster) and of being able to ket advance. Any delay in price fixing might sometimes provide real-life information to cooperatives and, increas- result in better prices but naturally can also result in a ingly also to lenders. much lower price. The program demonstrates that once cooperatives begin The notion of what could be called “variable sales” is to understand how the system works, they realize its advan- gaining acceptance, mostly in Peru where the Sustainable tages and are ready to pay the costs. Initially, however, Harvest program was first introduced. Call options were costs need to be subsidized, requiring suitable promotion bought by 20 cooperatives in all. This is notable because of the program’s advantages to those who might provide many lenders still believe that fixed price contracts are the best and safest option and so insist on them. This 52 Of course, lenders should also appreciate the role put options can play when might be safer for them but obviously not necessarily for it comes to the funding of unsold coffee stocks. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 37 the subsidies. Having said this, it needs also to be recog- cooperatives more familiar with market behavior, yet the nized that even with detailed education of cooperatives, in Sustainable Harvest system allows them to ask the advice 2013 a number of cooperatives with prior exposure to the of the importer and, most importantly, there is no need to program did not wish to invest in call options. The prevail- directly involve themselves in futures trading. ing view was that the market would remain depressed and that the cost of this insurance only increased the hardships CASE STUDY 6: THE 2012 imposed by an already low sales price. Ultimately, the mar- ket recovered and some cooperatives suffered extensive LATIN AMERICAN COFFEE losses in that subsequently they had to pay their members RUST OUTBREAK: “BLACK the higher ruling price to be able to meet their contracts, SWAN” OR “NEW NORMAL”?53 having sold or fixed at much lower prices previously. Coffee Leaf Rust (CLR, Hemileia vastatrix) is a serious fun- gal disease of Arabica coffee, which famously destroyed While the cost of options varies and is influenced by the the Ceylon (Sri Lanka) coffee industry in the 19th century. duration, the strike price, and the general market view. It is also clear however that options are more affordable for The disease reached Latin America in the 1970s, becom- producers of relatively high-priced coffees and the vari- ing ubiquitous by the late 1980s. Despite sporadic flares able sales approach may not be as attractive or affordable and outbreaks, the disease never quite lived up to its ear- for those producing lower-priced qualities (demonstrating lier notoriety and many farmers controlled it sufficiently once again there are no one-size-fits-all solutions). And with either routine calendar sprays or occasional “just-in- as with all aspects of marketing, managing the variable time” sprays. approach requires a level of sophistication that is absent in many cooperatives and other types of farmer organi- This situation now seems to have changed. Colombia zations. It takes time to understand the potential value suffered a serious outbreak in 2009/10, which coincided of price risk management generally, and the variable with a severe and enduring La Niña climate event. And approach in particular. Training programs should there- whereas previously the rust was never problematic at more fore be paced accordingly (extending even over a number than 1,600 m above sea level, these high-quality Arabica of years) and need to be updated with real-life examples zones now came under attack. and situations encountered in the most recent season to ensure the programs transfer real hands-on knowledge. The 2012 outbreak appeared to be a similar but much more widespread event ranging from Mexico in the north The program also provides good insight into the question to Peru in the south, with increased attacks also reported of why a buyer might consider subsidizing or sharing the in the Dominican Republic and Jamaica. The wide extent cost of call options. The answer is that a default (coffee and severity of the outbreaks caught almost everyone by bought is not shipped) usually causes major disruption to surprise, and it seems now certain that the 2012 outbreak the buyers’ supply line. In the case of high-quality, such is the most severe since the fungus was first discovered in missing coffee cannot be replaced as the buyer likely has Latin America in 1970 and possibly the worst since the purchased (and may have sold on) a specific type of cof- notorious Sri Lankan event. fee from a particular supplier; details that are often key marketing characteristics. Much of this business is done When the outbreak was developing, some observers felt on a forward basis, that is, ahead of the actual harvest. that the problem was somewhat exaggerated, but the most Therefore, the motivation for buyers in this approach is recent evidence confirms that it has indeed been a calam- to help ensure that the members will in fact supply the ity for many of the region’s coffee farmers (figure 5.5).54 specific coffee that the cooperative sold forward. 53 With thanks to P S Baker, CABI. 54 Graph: Proportional production changes of the eight largest countries that A final feature of the program to consider is that being reported rust outbreaks. Data from GAIN USDA reports; figures for year linked to a broker account has made the participating 2014/15 are based on estimates as of June 2014. 38 Risk and Finance in the Coffee Sector FIGURE 5.5. PROPORTIONAL of rust may be disguised by the strong growth in production PRODUCTION CHANGES BY COUNTRY there due to significant and ongoing area expansion. 1.2 El Salvador seems to have been the hardest-hit coun- 1.1 try, with a loss of more than half of its production in 2013/14; its lowest harvest in 80 years. Nicaragua too has 1 suffered serious losses, which may deepen over 2014/15. With the expected El Niño event in the latter half of 0.9 2014, decreased rainfall and high temperature could fur- 0.8 ther retard recuperation. 0.7 Costa Rica Thorough survey data at a sub-country level is mostly lack- Ecuador ing; the most detailed mapping by Anacafé Guatemala El Salvador 0.6 Guatemala reveals a complex pattern of CLR attack across the coun- Honduras try that displays neither a random nor a highly aggregated 0.5 Mexico Nicaragua distribution. Regional production data from Guatemala Peru 0.4 since 2010 shows large fluctuations, suggesting that the 2011 2012 2013 2014 problem may have been building for some time. Anecdotal accounts (personal observations, communi- The following study reviews evidence of what happened, cations, and press reports) indicate that the CLR attack why, and what might be done about it. affected a broad range of coffee growers; sun and shade coffee, organic, other certified and non-certified coffee, What Happened? large and small farmers—all have been affected (with the In the latter part of 2012 and the first quarter of 2013, rust possible exception of the resistant Catimor varieties). A outbreaks were reported from 10 Caribbean and Latin comprehensive breakdown by altitude, location, farming American countries: Costa Rica, Dominican Republic, El system, tree age, and so on is currently lacking, and this is Salvador, Guatemala, Honduras, Jamaica, Mexico, Nica- making it difficult to establish causality. ragua, Panama, and Peru. Later in 2013, Ecuador also declared an emergency, bringing the total to 11 countries. Why Did It Happen? Some facts about CLR epidemiology need to be under- From United States Department of Agriculture Global stood; a temperature around 22°C, the presence of liq- Agricultural Information Network (USDA GAIN) reports uid water, and darkness all favor germination, although published in May and June 2014,55 it seems that original esti- a lower temperature (13–16°C) apparently encourages mates for 2012/13 production losses were somewhat overes- growth of the spore tube that forces its way into the timated for Mexico and El Salvador. However, all countries leaf. The condition of the coffee tree is also impor- suffered declines in the crop year 2013/14, and estimates tant; poor nutrition and a heavy fruit load increase for 2014/15 suggest that production will still not be back to the likelihood of heavy infection. When trees in sun 2011/12 levels (figure 5.5). To date, production from these and shade have equal fruit loads, shade can bring on countries has declined by over 10 million sacks since the heavier attacks, but this is confounded by the gener- 2011/12 season, although it is not possible to claim that all ally lower fruit loads that occur under shade through losses are due to rust (other factors including drought may be reduced flowering. involved). In the cases of Honduras and Peru, the full effect Despite this knowledge, even two years after the prob- lem started, there is a lack of understanding as to why See http://gain.fas.usda.gov/Recent%20GAIN%20Publications/Coffee%20 55 CLR became such a widespread problem in 2012. Annual_San%20Salvador_El%20Salvador_5-7-2014.pdf. Attempts to explain what happened fall into two main A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 39 camps: either it represents a virulent new strain, or this was more or less neutral. A problem for scientists is that is the impact of unusual weather conditions influenced meteorological data from the region is poor, especially by climate change. considering its complex topography. Additionally, avail- able survey data does not help to determine the extent to The virulent strain hypothesis. The possibility of a mutated which the upsurge might be caused by the inexperience of strain of CLR as the cause of the Colombian epidemic farmers at higher altitudes as opposed to increased CLR was investigated in some detail by the National Center aggressivity at lower altitudes. Although increased rain for Coffee Research (Cenicafé) scientists (Rozo and others is often indicated as a cause of fungal outbreaks such as 2012). They carried out quite extensive studies involving rust, data from both Costa Rica (The Costa Rican Cof- comparisons between pre- and post-2008 spore samples, fee Institute [ICAFE] DATE) and El Salvador (Fundación which included genetic marker analysis and seedling Salvadoreña para Investigacion es del Café [PROCAFE] infection experiments on a range of varietals to measure DATE) suggest that rainfall was lower and more intermit- virulence. They could find no significant differences and tent in 2012. Possibly, therefore, an unusual combination concluded that a new strain was not responsible. of rainfall and temperature proved ideal for rust prolif- eration in some zones. However, we are still far from a It seems likely, therefore, that the same conclusion can be full understanding of the events that triggered so many applied to the 2012 outbreak. Indeed it would seem improb- outbreaks. able that a virulent strain could spontaneously appear over such a very large geographic area in the same year. The ecological collapse hypothesis. This proposes that increases in pests and diseases are due to increasing intensification, Furthermore, there are reports of other coffee diseases, especially the eradication of shade. However, the 2012 notably Ojo de Gallo (American Leaf Spot, Mycena experience shows that shade and organic coffee farms citricolor) increasing in several countries. Cenicafé, for were sometimes heavily attacked. For example, at the El instance, has recorded unusually high levels of M. citri- Programa Cooperativo Regional para el Desarrollo Tec- color on unshaded coffee in Cesar and Cauca in Colombia nológico y Modernización de la Caficultura (PROME- (Rivillas and Castro 2011) and HR Neumann Stiftung CAFE)–World Coffee Research (WCR) rust meeting in technicians in Central America working on the coffee and April 2013, Anacafé’s Miguel Medina said: “I don’t know climate initiative56 recently rated the disease as second in how organic coffee can have a future. There is nothing importance only to CLR (Baker DATE). It is therefore that works to control rust in the field and I am not seeing stretching credulity to believe that two diseases are mutat- anyone in the market offering more to create additional ing to higher virulence and instead an explanation that incentives for organic farmers.” accounts for all such changes is desirable. The climate hypothesis. Climate change as the cause of the Since the best data come from Colombia, which has an CLR outbreaks has been widely discussed and it is a fact extensive network of meteorological stations, the follow- that the fungus now attacks at higher altitudes than a dec- ing scenario is offered based on a description of events in ade or more ago (up to 2,000 m reported in Colombia). Huila, Colombia in 2010 (Federación Nacional de Cafet- Since a clear warming signal can be found in the mete- eros 2010): orological data across the region, it is virtually certain that 1. A long “La Niña winter” in 2008 and 2009 left climate change has caused this new outbreak pattern. coffee trees in poor condition because of reduced efficacy of fertilizer applications under prolonged However, this does not explain why 2012 was such a bad rain and low light. But CLR levels were not year, especially since it was not a particularly hot or wet excessive at this time because flowering (and hence year; in terms of the El Niño/La Niña oscillation, 2012 fruit loading) were low. 2. In the first half of 2010 there was an intense sum- mer period that induced heavy flowering, leading 56 http://www.coffeeandclimate.org/Trifinio.html. to expectations of a bumper crop. 40 Risk and Finance in the Coffee Sector 3. Wet conditions returned in the second half » Gather more information and research on: of 2010, with prolonged rain and high mini- • Weather: temperature, amount of rain and rain mum temperatures (caused by heavy cloud) patterns, relative humidity, solar light and shade, that produced ideal conditions for CLR El Niño and La Niña. proliferation. • Levels of infection, incidence, and severity. 4. Already weak coffee trees, now struggling to cope • New crop varieties and more testing and im- with a heavy burden of growing berries, easily provement of quality of Catimors. succumbed to CLR attacks, shedding much of the • Socioeconomic information about farmers. expected harvest. • Not only CLR, but other diseases. • Trials on farming systems: tree density changes The above scenario may not correspond to the 2012 and shade modification to increase resilience of event, but it is likely that a similar combination of fac- coffee plantations. tors led to conditions ideal for CLR. A major difficulty is • Rust—its genetic variety and virulence. that without knowing the specific events that caused the » Campaign to renovate plantations and promote outbreak, it is impossible to assess how rare they were and better farming practices. therefore how likely their return might be. » Carry out physical and chemical soil analysis and promote better soil use and conservation. What Should Have Been Done Differently? » Create insurance programs. At the Guatemala rust summit in April 2013, a working » Better equip extension services for knowledge and group compiled the following list of shortcomings: technology transfer. » Chronically insufficient economic resources to deal with the rust; most farmers make very modest prof- Widely expressed opinions were that an attitude change its and spraying is costly, so why do it if CLR has is now required by all stakeholders to understand the not been a problem? implications of more extreme and more prevalent cli- » The problem was underestimated; some warning matic conditions and to acknowledge the need to be signs were there but were not acted upon. more proactive. » Ineffective application techniques (poor droplet size, wrong frequency and timing of applications) Current Responses due to lack of training. Efforts are underway to regenerate coffee production in » Poor infrastructure; very bad roads after storms in Central America, most notably a collective effort led by 2010 leading to more difficult access to farms. USAID and partners totalling US$23 million.57 Generally » Conflicting advice: technologists promote rust though, responses have been slow with nothing like the resistant varieties, roasters prefer susceptible va- amount of money and effort expended in Colombia, rieties. where reportedly the government has spent over a billion US dollars on coffee renewal since 2010.58 The same working group recommended the following to prioritize limited resources to deal with present situation Field studies being carried out by the coffee and climate and lower its impact in future years: initiative in the Trifinio region of Central America report » Improve information collection: Systematize, ana- that, to date, farmers have received little or no govern- lyze, distribute, and share with producers to take ment assistance. Data from project farms show that corrective and preventative actions. » Develop diagnostics and monitoring for early warning. 57 http://seattletimes.com/html/businesstechnology/2023841749_starbucksrustxml » Increase use of new technology and improve pro- .html. ducers’ networking capacities, for example, cell 58 http://www.marketwired.com/press-release/coffee-colombia-offers-millions- phones. aid-help-countrys-coffee-plantations-adapt-climate-change-1754060.htm. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 41 FIGURE 5.6. FIELDBOOK DATA FROM COFFEE AND CLIMATE INITIATIVE PROJECT FARMS IN THE TRIFINIO ZONE Mean agrochemical spend (USD/ha) El Salvador Honduras Guatemala 80 9000 Mean yield (kg cherry/ha) 8000 60 7000 6000 40 5000 4000 20 3000 2000 0 2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013 2009/10 2010/11 2011/12 2012/13 2013/14 Year EL Salvador Guatemala Honduras Source: Data from HRNS, analysis by E. Briggs. production has fallen, especially in 2013/14, whilst spend- It is unclear the extent to which climate change may ing on agrochemicals has risen sharply (figure 5.6). have contributed to this, but there is convincing evi- dence that extreme weather events are now more com- Now in 2014, although the outbreak seems to have abated mon in Central America (ECLAC 2012) (figure 5.7) somewhat, it is by no means over. This implies that farmers and indeed also elsewhere, including events that favor wanting to retain coffee will have to either change variety one or more pests or diseases and disrupt a normal or be prepared to proactively spend additional funds every equilibrium. year to prevent regular losses. The associated cost impli- cations need to be quickly evaluated; more farmers are As a result, farmers’ risk levels have risen; it is becom- adopting high-yielding resistant varieties, but they tend to ing more difficult to farm in many localities because lack the funds to invest in the fertilizers required to fully of changed weather patterns. It is especially risky benefit from them. for farmers of perennial crops, such as coffee, which require substantial investment with a long payback Although prices rose in February 2014 because of the Bra- period. Hence, farmers’ recent experiences of yield zilian drought, it came after most farmers had already sold and quality losses, higher input costs, and little or no their crop. Prices are now falling again and it is far from price compensation suggest that many lack a long-term clear under what conditions farmers can expect to make a sustainable strategy. profit. Should they borrow money to reinvest and intensify production as some agencies are urging, or should they Conclusion diversify in the face of what seems to be increasing vagar- The gravity of the outbreak, together with the large degree ies of both price and climate? This dilemma is currently of unpreparedness, points to a systemic failure—that is, a the subject of close scrutiny by project staff. failure of anticipation, insight, and overall management by the coffee industry and the public sector that underlies Black Swan or New Normal? individual and institutional shortcomings. A so-called black swan event is a rare occurrence, such as the global financial crisis of 2008. Was the 2012 CLR This is surprising, given the extent to which the con- outbreak a similar peculiar event or a signal that underly- cept of sustainability has risen to prominence over the ing conditions have changed? The fact that the 2012 event past 10 years. It is becoming clear that the shortcomings was presaged by the 2008–10 experience in Colombia of this approach have been an over-concentration on suggests that underlying conditions indeed may be chang- micro-management of a large number of farm-level tasks ing and that it would be perilous to ignore them. and a relative failure to look at larger-scale material issues 42 Risk and Finance in the Coffee Sector FIGURE 5.7. INCREASE IN TROPICAL FIGURE 5.8. WORRIED WELL: STUDIES STORMS AND HURRICANES ON HOW COFFEE AFFECTS SINCE 1990 CONSUMERS’ CANCER RATES 16 HAVE TRUMPED SUPPLY 1990–08 14 PROBLEMS LIKE RUST 1970–89 70 12 Frequency of events Hemileia vastatrix 10 60 Cancer Number of publications 8 50 6 40 4 30 2 0 20 Belice Costa El Guatemala Honduras Nicaragua Panama Rica Salvador 10 Source: Presentation of Julie Lennox, Punto focal de cambio climatico y 0 Jefe Unidad de Desarrollo agricola. Sede subregional de la CEPAL en 1910 1930 1950 1970 1990 2010 Mexico. Source: CABAbstracts. such as pests and diseases, water use, land use change, and overall economic farm performance. CASE STUDY 7: RECENT This state of inadequacy is in turn a direct result of the EXPERIENCES OF COFFEE history of coffee over the past generation, which has REPLANTING PROGRAMS stressed market-driven measures to realize maximum IN COLOMBIA59 value, whether through quality or some more symbolic Overview attribute of sustainability. Unfortunately, the many NGO- This case study reviews Colombia’s efforts to improve driven initiatives to promote sustainable production have the competitiveness of its coffee sector through replant- not been able to substitute for the long-term support of ing and technical innovation between 1998 and 2011. science and technology that has historically been provided These efforts were largely successful, but it should be rec- by public institutions. ognized that this was largely due to a truly supportive or enabling sector environment. This comprised govern- This in turn has led to a weakening of research and exten- ment, research institutions, strong grower organizations, sion services, which are ill prepared for what is now most and a concerted investment program funded by the likely an era of accelerating change. The relative collapse National Federation of Coffee Producers and the govern- in the field aspects of coffee science can be seen from the ment. Several lessons emerged from these efforts: Grow- decline in the number of CLR science publications rela- ers sometimes resist innovation and renewal as a result tive to, say, those on the relationship between coffee and of risk-aversion, lack of knowledge, and/or the absence cancer (figure 5.8); research on the medical effects of cof- of the right incentives; multi-year program designs need fee consumption now greatly outweigh agronomic studies. constant review and adjustment, when necessary; and access to finance plays a major role in the success of The coffee industry now needs to re-examine funda- replanting programs. Furthermore, through these efforts, mental concepts about how it nurtures and protects the the resilience of the sector to production risk, such as complex social-environmental system that supplies its raw pest and diseases, was significantly increased. However, material. Tacit and explicit assumptions of risk, stability, resilience, and sustainability need to be reviewed in the light of recent events. 59 The case study was prepared by Luz Diaz Rios, World Bank. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 43 FIGURE 5.9. COLOMBIAN COFFEE FIGURE 5.10. COFFEE PRODUCTIVITY PRODUCTION (MILLION BAGS) (60 KG BAGS/HA) 14 18 16,75 12 15,76 16 14,14 14,38 10 14 8 13,06 12 6 10 9,76 4 8 8,80 8,48 2 0 6 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011* Source: FNC. Source: FNC. a final conclusion is, unfortunately, that despite these atomization of production (that is, coffee production by efforts, prolonged periods of low prices, which greatly a large number of growers utilizing relatively small plots). reduce farmer profitability, put this and similar under- takings elsewhere at risk. The decline in production occurred in spite of the replanting programs put in place since the late 1990s, 1. Background. Until the mid-1970s, Colombia’s which resulted in the renewal of a total of 725,200 hec- annual coffee production exhibited a steady pattern, with tares during 1998 to 2011. A detailed description of the average production estimated at 8.7 million 60 kg bags/ scope of these programs and of their achievements is year. Production started to increase during the second provided later in this study, but in short their main objec- half of the 1970s following a modernization program tive was to improve the age and quality of the tree park, launched by the Colombian Coffee Growers Federation which was considered vital to lifting the competitiveness (known by its Spanish language acronym, FNC)60, favora- of the Colombian coffee sector. Two replanting programs ble world market conditions, and technological innova- implemented since 1998 fulfilled two different but related tions. These factors helped to lift productivity from an objectives. The main objective of the Competitive- average of seven 60 kg bags per hectare in 1970 to 12–14 ness Program (CP), implemented during 1998–11, was bags/hectares in the 1980s. During the early 1990s, pro- to maintain crop productivity in densely cultivated cof- duction increased significantly, reaching a peak of 16 mil- fee growing areas. On the other hand, the Permanence, lion bags in 1992/93, but subsequently declined again Sustainability, and Future (PSF) program, implemented to the levels seen in the 1980s. It remained at those lev- since 2007/08, was designed to rejuvenate aging coffee els (around 11.5/12 million bags) until 2007, when it plantations through new plantings, and it specifically tar- fell sharply again (figure 5.9). Government and industry geted small-scale producers. pointed to a combination of contributing factors as caus- ing this situation, including: declining productivity per 2. The Coffee Competitiveness Program (CP): hectare (estimated at only 8.48 bags/ha/year in 2011— Maintaining the Productivity of Young Planta- figure 5.10); slow adoption of technological innovation, tions. During the 1990s and early 2000s, the world cof- particularly in terms of improved varieties; low levels of fee industry underwent fundamental changes in both the fertilizer use; aging producers and plantations; and the demand and supply sides. On the supply side, the period was characterized by a dramatic increase in coffee planting that, according to some, would practically ensure struc- 60 The FNC was created in 1927 by the collective effort of the coffee producers. tural long-term overproduction, particularly in countries The FNC was to be financed through a tax on exports and was also granted the producing unwashed Arabica and Robusta. In response, right to manage the tax funds through a grant agreement with the government. Since its creation, the FNC has been the major organization through which sec- in the late 1990s, the FNC made the stabilization of pro- tor policy is coordinated and directed. duction (at 11–12 million bags/year) one of the strategic 44 Risk and Finance in the Coffee Sector FIGURE 5.11. PRODUCTIVITY AS A FIGURE 5.12. PRODUCTIVITY AS A FUNCTION FUNCTION OF CROP DENSITY OF PLANTATION AGE 450 25 400 Arroba dried coffee/ha 350 20 300 125 kg bags/ha 250 15 200 150 100 10 50 0 5 – 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000 11,000 12,000 13,000 14,000 15,000 I II III 0 Trees/ha 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Source: FNC. Year Source: FNC. pillars necessary to maintain a competitive coffee industry. mit to renewing at least 400 trees. For growers with less By then, Colombia’s coffee sector was relatively produc- than five hectares, a maximum of one hectare could be tive, with nearly two-thirds of production (62 percent) renewed under the program; those with five hectares or from plantations under modern production systems or more were allowed to renew 20 percent of their coffee high-input systems61). However, the remaining 38 percent area. Rejuvenation of the plantations could be achieved was grown under traditional low productivity systems. As either by planting new trees using seedlings or by full the objective of the CP was to maintain the productivity of stumping of existing trees; for new plantings the optimal young plantations, plantation age and tree density became densities had to be between 2,500–10,000 trees/hectares. critical parameters of activity. For the Colombian varieties released by Cenicafé62, productivity increases are experi- Availability of plant nutrients is a critical factor in the enced at high plant/crop density levels between 6,000 to successful establishment of new plantations, particularly 8,000 plants/ha (figure 5.11), and by keeping the average where the stumping method is used, as the tree is left age of plantations at around five years (figure 5.12).63 without leaves and must survive on nutrient reserves in the roots alone. Facilitating access to fertilizer was there- The program targeted plantations more than five years old fore the basis for the incentive granted to farmers under and located in optimal coffee production areas (high-input the CP. In 2011, coffee growers received fertilizer to the cropping systems). To participate, growers needed to com- value of nine US cents for each renewed plant. Growers interested in participating in the program would discuss their plan for renewing plantations with FNC staff, at 61 These systems (usually called café tecnificado) use densities equal to or above which time the scope of the replanting program would 2,500 trees. Tree age should be equal or less than nine years old for full sun sys- tems and equal to or less than 12 years old for semi-shaded production systems. be determined through topographic plans, aerial photo- 62 The Centre of Coffee Research (Cenicafe) was established in 1937 by the graphs and/or exhaustive counting of plants. Under CP, FNC, and has since remained under the management of the FNC. The institu- the incentive (in the form of fertilizer) was provided to tion has been leading research efforts on varietal development, pest and disease the grower once the FNC staff verified in the field that control, and other critical aspects of coffee production. The research program on varietal development for Coffee Leaf Rust (CLR or roya, in Spanish) resis- the old plantations had been replaced (either by plant- tance started in the late 1960s; in 1982, the first CLR resistant variety was ing new seedlings or by full stumping). Where the chosen released known as variedad Colombia. The variedad Castillo, released in 2005, rejuvenating method was new planting, the producer was has resistance to CLR and also to other sanitary problems facing the crop. responsible for producing the seedlings to be used. 63 Recommended planting densities vary according to a set of factors; how- ever, for high-input cropping systems at full sun exposure, average crop den- sity is about 2,500 to 10,000 plants/ha with average replanting rates of five to However, cashflow problems are a major drawback to the suc- nine years. cessful implementation of replanting programs, particularly A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 45 FIGURE 5.13. RENEWED AREA UNDER THE COMPETITIVENESS PROGRAM (’000 MT) Renewed Hectares/Year Acumulated 90 700 627 79 609 80 584 73 548 600 70 501 63 60 454 500 60 55 417 380 50 341 47 47 400 306 40 35 39 37 37 36 251 300 30 196 25 200 136 18 20 63 100 10 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FNC for those producers relying on coffee as their major source of In 2010, under the Coffee Prosperity Accord signed income, as new trees will not yield for a period of up to two between the Colombian government and the FNC, a new to three years, depending on the rejuvenating method used. target was set for the program at about 40,000 renewed The FNC therefore promoted multi-cropping (with beans hectares per year. In 2010, the government provided and maize) as a way to support diversification and farmer nearly COP20 billion (nearly US$9.3 million) to sup- income during the gestation period of the new plantations. port the program, yet only about 25,000 hectares were This approach proved to be very successful. renewed through the program in that year. Growers willing to multi-crop while renewing plantations Although, for the most part, the overall objective of sta- received additional incentives for fertilizer purchases. bilizing production at 11–12 million bags per year was These incentives also facilitated the coordination of sup- achieved, fewer gains were made in terms of maintain- port among different organizations, including access to ing a young and productive sector. In fact, by 2005/06, quality seeds, extension services, and improved production the landscape of the coffee Colombian sector had dra- technologies for those crops. Consequently, the programs matically changed in that the percentage of coffee grown resulted in significant gains for producers in terms of bet- under low production or traditional systems had increased ter maize and beans productivity, and income generation. to 55 percent from 38 percent; the plantations were aging and becoming unproductive. In 2006, the average age of During the 13 years of implementation of the Competi- plantations was estimated at 13.9 years. tiveness Program to 2011, 605,000 hectares of coffee were renewed, with total investments estimated at about Many critics regarded the Competitiveness Program as COP37263a billion (around US$181 million). However, targeting medium- and large-scale producers or those with the initial goal was to renew about 70,000 hectares annu- alternative income-generating activities who, presumably, ally and while this was achieved in the early years, only were able to rejuvenate plantations even in the absence around half the target was met between 2003 and 2006, of the program. The design of the program relied on possibly due to the then discouraging state of the coffee meeting the fertilizer needs of the young plantations but, market. For the remaining years, the annual targets were other than the multi-cropping systems, included few or revised downward but still without success (figure 5.13). no provisions to support producers during the tree gesta- tion period, an omission that proved to be a significant COP = Colombian peso. 63a impediment to the participation of small-scale producers. 46 Risk and Finance in the Coffee Sector Yet, if substantial gains were to be achieved in the replant- TABLE 5.4. CREDIT LINES AND PROGRAMS ing program, the needs of the small-scale producers OF INCENTIVES FOR COFFEE (representing nearly 95 percent of all producers) had to be GROWERS, 2011 better addressed. Accordingly, in 2007, the FNC launched Loan COP for a parallel replanting program named “Permanence, Sus- Replanting 1 ha Payments COP tainability, and Future” or PSF, to specifically target small- scale old or aging plantations (under both traditional and Size of 6,000,000* Producer (60%) 3,600,000 the loan high-input systems).64 Both replanting programs (CP and PSF) co-existed until 2011, but in 2012, the Competitive- Interest to 2,133,334 Government 2,400,000 ness Program was phased out (although specific credit be paid ICR (40%) lines were made available to middle- and large-scale pro- Total 8,133,334 National Coffee 2,133,334 ducers to continue support for rejuvenation). Fund (FNC) 100% interest 3. The Permanence, Sustainability, and Future Source: FNC, 2011. (PSF) Program—Targeting the Needs of Small- * Approximately: US$3,000 applying the average exchange rate in 2011. scale Producers. The PSF program, launched in 2007, aims at improving income and reducing poverty among small producers. Leadership is provided by the FNC, (2) an incentive known as Rural Capitalization Incentive but the program is implemented in coordination with (ICR), which covers 40 percent of the principal and is the national agricultural financing fund, Fondo para el paid by the government; and (3) an additional incentive Financiamiento Agropecuario (FINAGRO), and with covering interest on the loan paid by FNC. Under the financial support from the government. Although initi- program, participating producers contribute repayment ated in 2007/08, PSF became a sector flagship program in of 60 percent of the loan and the labor costs associated 2009 with the signature of the “Coffee Prosperity Accord with renewing and maintaining their plantations. Loan 2010–15” between the FNC and the government. Under duration is seven years with a two-year grace period. An the Accord, targets included the establishment of 200,000 illustration of the way the program worked in 2011 is pre- new hectares annually to reach a million planted hectares sented in table 5.4. in 2015, and the rejuvenation of 300,000 hectares during a five-year period, both through the CP and PSF programs. The PSF was structured to temporarily compensate pro- ducers during the unproductive period associated with The PSF program is designed to renovate, through new new plantings—the minimum/maximum qualifying area plantings, coffee areas cultivating aging coffee trees. In sizes were, however, adjusted during the program’s imple- clear contrast to the Competitiveness Program, which mentation. In the early years, small-scale producers with used fertilizer purchases as incentives, the basic incentive five hectares or less were allowed to renew a maximum in the PSF grants bank loans on favorable terms to small- of 1.5 hectares under the PSF; in 2011, the minimum scale coffee producers. area was 0.2 ha and the maximum 5 ha. Given tight FNC The credit/loan combines two elements—guarantees and finances, however, the PSF in 2012 ceased covering loan incentives, as follows: (1) A hundred percent credit guaran- interest, with responsibility for payment falling to the pro- tees pooling the credit risks provided by two organizations: ducer. Similarly, there were changes in the disbursement the National Guarantee Fund, managed by FINAGRO of the loans, with distributions provided in two payments and the National Coffee Guarantee Fund, established and instead of eight, with the second payment conditional managed by the Federation of Coffee Producers (FNC); upon verification that the plantation had in fact been reju- venated through new plantings. 64 One of the criteria to be considered a small-scale producer is that at least two- Since 2007/08, PSF had disbursed an estimated thirds of income is generated by agriculture. COP691billion (US$361 million), of which about A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 47 40 percent were government grants (representing inputs to reduce the impact on productive coffee trees US$145 million).65 A total of 118,000 hectares were between two and seven years of age and susceptible to renewed and about 146,000 farmers benefited. the disease; nearly US$22.5 million was invested in the program in 2011. As a result, the level of infestations fell 4. Pest and Disease Outbreaks and Their Impact from a national average of 44 percent in May 2010 to on the Replanting Programs. A series of difficulties 10.8 percent in November 2011 and to 5.3 percent in have plagued the coffee sector in recent years, particu- the 2012/2013 season. The FNC estimates that the total larly pest and disease infestations, including coffee borer investment in CLR control at about US$60 million. and coffee leaf-rust (CLR or roya). The latter in particular harmed the productivity and income of thousands of pro- All this had an important impact on the strategy ducers during 2008–10. The factors fostering the spread applied in the replanting programs, with the use of rust- of this fungus (hemileia vastatrix) are diverse, including a resistant varieties in crop renewal becoming a prereq- combination of environmental factors, poor crop manage- uisite. Until 2010, the variety to be grown was decided ment, and susceptible varieties. Environmental factors have by the producer but since 2011 participants in replant- included high rainfall patterns resulting from the La Niña ing programs are required to plant resistant varieties. effect, together with reduced sunlight due to cloudy skies In 2011, the results of this strategy were quite positive; and a narrower range between maximum and minimum more than 80,000 hectares were rejuvenated with resist- daily temperatures. In the Colombian central coffee-grow- ant varieties. Furthermore, new targets were set for the ing region—a main coffee region—annual precipitation next five years with the expectation of renewing about exceeded 3,000 mm during multiple years, presenting 130,000 hectares annually with rust-resistant varieties.67 optimal conditions for leaf-rust development. Inadequate This move was not well received by many farmers who fertilizer application, evidenced by low fertilizer sales,66 had been growing the traditional varieties for decades; and deficient nutrient uptake in water-saturated soils has yet, it was and is considered as an essential strategy to slowed shoot growth, thus preventing plant recovery. effectively manage the disease and allow production to recover to previous levels. Furthermore, the predominance of susceptible varieties in the national tree park also contributed to the sever- The disease outbreak also intensified the focus on the ity of the outbreak. Although developing coffee varieties quality of the seedlings being planted and, in fact, rep- had been at the core of the research undertaken by the resented a turning point, as it catalyzed changes in the National Center for Coffee Research (Cenicafé) and led way seedlings were produced. Traditionally, seeds for to the development of varieties showing resistance to leaf both replanting and new plantings were the result of the rust, adoption by producers has been very slow. In 2006, farmer’s own selection, but for the new resistant varieties half of the national area under coffee (51 percent) was the FNC recommendation was to purchase the seeds in planted with the Caturra variety, and 20 percent with Tipica certified shops. Even so, there was no overall control of (both varieties susceptible to leaf rust) and only 29 percent the quality of the seedlings actually planted. Therefore, had been planted with resistant varieties. since 2011, Cenicafé has been providing seedlings to ensure their quality (specifically of the Variedad Castillo, The outbreak triggered an emergency response from resistant to CLR). A network of private nurseries super- the government and FNC through the provision of vised by Cenicafé has also been established to ensure that the increasing demand for good quality seedlings is 65 Government investments in PFS for the five-year period of the Coffee Pros- satisfied.68 perity Accord 2010–15 were estimated at COP$540 billion (around US$274.6 million when applying the average annual exchange rate in 2009), while the payments to be made by the FNC for loans interest were estimated at COP523 67 In 2012, nearly 117,000 hectares were renewed. billion over during 12 years. The growers’ contribution was estimated at about 68 This strategy faces significant challenges specifically if farmers start reproduc- COP$810 billion or more than US$400 million. ing the materials on their own, with the subsequent risk of gradually losing the 66 Some authors highlight low levels of fertilizer used due to high fertilizer costs source of resistance to CLR. The investments required to ensure full traceabil- resulting from high oil prices. ity of seeds across the sector can be considerable. 48 Risk and Finance in the Coffee Sector FIGURE 5.14. PSF MAIN ACHIEVEMENTS: INVESTMENTS, COVERED AREA, AND PRODUCER BENEFICIARIES Number of hectares per year ('000) 70 Number of beneficiary producers per year ('000) 332.3 350 Loan investments per year (COP$ billion) 60 300 50 212.1 250 40 200 30 114 61 150 55.3 45.8 20 37.9 100 29 10 31.2 20.1 50 1.3 7.2 9.7 0 0 2007 2008 2009 2010 2011 Source: FNC. 5. Overall Achievements, Successful Factors, and FIGURE 5.15. RENEWED AREA Remaining Challenges.69 Through the CP and the COMPETITIVENESS AND PSF initiatives, a total of 725,200 hectares were renewed PSF (’000 HA) during 1998–11 (figure 5.14). Investment in these pro- 90 grams has been considerable; US$325 million is a rough 80 70 estimate of the investments made as grants covering fer- 60 50 tilizer purchases and as subsidies to cover the 40 percent 40 of the loans taken by producers that they did not need to 30 20 repay; however, this does not include the amount invested 10 0 by the FNC in covering loan interest during 2008–11. 98 99 00 2 03 04 05 06 07 08 09 10 11 -0 19 19 20 20 20 20 20 20 20 20 20 20 Investments (basically for fertilizer purchases) during 01 20 1998–05 represented only 34 percent of the total grant Source: FNC. investment under these two programs (excluding grants to cover loan interest). The FNC estimated the total invest- ment through these programs at about US$1.4 billion. FIGURE 5.16. TOTAL AREA RENEWED (2006–11) Although the contribution of the programs to ensure a Own producer initiative (%) Competitivity program (%) PSF (%) Total production ('000 Ha) young and quality tree stock has been significant, rejuvena- 140 117 120 tion initiatives by producers themselves (that is, without pro- 100 gram incentives) have also been remarkable. In 2011, record 76 82 80 69 66 69 figures were recorded with total 117,000 hectares rejuve- 60 nated, 40 percent resulting from individual producer initia- 40 tives and 60 percent with program support (figure 5.15). 20 0 The resilience of the sector to CLR is increasing. The 2006 2007 2008 2009 2010 2011 area planted with resistant varieties has increased from 29 Source: FNC. 69 Sources of the data used in the figures presented in relation to the replanting percent in 2006, to 43 percent in 2011 (figure 5.16). More programs have been extracted from the NFCG Annual Reports and a Power- Point presentation provided by Santiago Silva Restrepo (August, 2012), Advisor recent figures indicate that about 55 percent of the total to the Colombian Government in Coffee Matters. area in Colombia is now planted with resistant varieties. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 49 FIGURE 5.17. TOTAL PLANTED AREA AND increased, in part due to ongoing conflict in rural areas SHARE (%) BY VARIETY as well as increasing competition from urban jobs. This is Caturra (rust-leaf suceptible) Resistent var. causing labor shortages in the main and traditional cof- Tipica (rush-leaf suceptible) Total area (thousand Ha) fee regions that affect the cost of production, especially 120 930 for highly productive, labor-intensive farms.71 Some ana- 100 919 920 912 910 lysts suggest that growers with areas under coffee in the 80 51 53 53 54 52 46 900 range of 3.5 to 5 hectares will be in a better competi- 60 888 890 tive position to produce coffee profitably. For other grow- 880 40 29 874 878 879 ers operating large, extended areas or owning only very 29 30 31 33 43 870 20 small areas, coffee might not be a very profitable activity. 860 20 0 18 17 16 14 11 850 For large growers, labor costs present a significant barrier 2006 2007 2008 2009 2010 2011 while the investments by very small-scale coffee producers Source: FNC. might not produce the income necessary to support both basic needs and maintain crop productivity. These emerg- Furthermore, the programs contributed significantly to ing analyses will certainly impact on future investment in reversing the trend of plantations aging and becoming the sector, but Colombian coffee stakeholders expect that unproductive. In 2011, the average national plantation the proactive and also reactive measures implemented in age was 9.3 years (and down to 8.2 in 2012), compared to recent years will restore the productivity levels achieved 13.9 years in 2006. Similarly, during 2006–11, the average prior to 2008, as production increased significantly during planting density increased from 4,431 to 4,883 trees per the 2012/2013 season (reaching 10.9 million bags). hectare (figure 5.17). However, the challenges associated with low profitabil- Critical to the success achieved so far has been the shift in ity (acknowledging the impacts of global and domestic rejuvenation incentives, from providing inputs to provid- coffee prices), increasing production costs, and declin- ing bank loans and credit guarantees. Creating reliable ing price competitiveness due to a strong Colombian distribution systems of disease-resistant varieties has been peso are generating significant social tensions in coffee- equally important. However, none of this would have producing regions. Accordingly, since 2012, measures been possible without the collective efforts of the sector to increase productivity via replanting and renovation (that is, the FNC and its institutions, Cenicafé and the cof- have been complemented by a new policy designed to fee extension service70) coupled with the financial support compensate producers for low prices (below a defined of the government. Put differently, this combination rep- threshold.) This policy is, however, proving extremely resented a fully enabling sector environment. costly and fiscally unsustainable; in 2014 alone, the gov- 6. Conclusion. While the results of increasing produc- ernment committed approximately US$500 million tivity via maintaining young plantations of resistance for direct payments to farmers.72 The government has varieties in Colombia have been remarkable, the sector’s therefore appointed a commission charged with drawing main challenge is profitability, which has been in decline. up a new strategy for the sector, including critical aspects An unfavorable exchange rate and high labor costs are main factors responsible for the declining competitive- 71 Recent figures estimate the cost of producing a ton of coffee in Colombia at ness of the industry. Colombia’s cost of rural labor has more than US$2,700; while the average production costs of other mild types in competing Latin American and Caribbean countries is US$1,450 and about US$1,400 in the rest of the world. Of the total production costs in Colombia, 70 The FNC established its coffee extension service in the late 1920s, and it cur- the share of labor is estimated at 60 percent, while fertilizers represents about rently comprises about 1,600 professionals. The extension system has been sup- 20 percent (Portafolio, November 5, 2013). ported through growers’ contributions for each pound of coffee exported (funding 72 The price of Arabica coffee has significantly increased since January 2014, the FNC), and, more recently, also through a technical assistance Incentive (IAT, as a result of expected declining production in Brazil and Central American by its Spanish acronym) provided by Colombia´s Ministry of Agriculture and countries; this, combined with the prospect of further improvements in cof- Rural Development. In 2009, the extension service achieved certification against fee production, is releasing some of the tension, and also reducing the need to the ISO 9001:2008 standard for the quality of the services provided. apply price compensation payments. 50 Risk and Finance in the Coffee Sector FIGURE 5.18. AVERAGE PLANTATION AGE AND AVERAGE PLANTATION DENSITY Average plantation age (years) Average plant density (trees/Ha) 2011 9.3 2011 4,883 2010 10.8 2010 4,811 2009 11.5 2009 4,731 2008 12.2 2008 4,686 2007 12.8 2007 4,623 2006 13.9 2006 4,431 0 2 4 6 8 10 12 14 4,200 4,300 4,400 4,500 4,600 4,700 4,800 4,900 Source: FNC. such as credit, sector profitability, exchange rate volatil- BOX 5.1. LIVELIHOOD TRIAD ity, producer price stabilization schemes, coffee institu- BASIX is an Indian institution that began in 1996 and tions, and research. It also seeks to address structural focuses on livelihood promotion by providing financial changes needed to ensure the long-term competitiveness services and technical assistance in an integrated man- of the sector, which remains of critical socio-economic ner. BASIX works with more than 3.5 million customers, importance to the country.73 over 90 percent being rural households and the remain- der urban slum dwellers. BASIX operates in 17 states, 223 districts, and 39,251 villages. The foundation of BASIX’s CASE STUDY 8—UTILIZING work with these clients is the livelihood triad: TECHNOLOGY AND “BOOTS ON THE GROUND” TO REACH Institutional development services NEW CUSTOMERS IN INDIA: THE SUB-K APPROACH74 Objective: Extend financial services to underserved rural areas. Livelihood financial Agriculture/Business development services services Response: Indian financial services provider Sub-K has developed a scalable technology platform called ViT- RANSP for extending multiple types of banking services to rural areas. It has designed and established a set of opera- BACKGROUND tional processes to accompany these banking services and One of the major limitations in agricultural lending is the facilitate their rollout and usage. The pilot approach has ability to reach rural clients in a timely, cost effective, and now concluded, and the service is now operational. efficient manner. Given the limited branch network in rural areas, the lack of rural infrastructure, and the costs associated with getting to know clients in rural commu- nities there was a need for innovation to provide greater 73 Coffee’s share of total country agricultural and food exports was estimated at 30 percent in 2012 and approximately 3 percent of total country, exports. Cur- access to financial services in India. BASIX, through Sub- rently, more than 500,000 producers are involved in coffee activities. K, is looking to use technology coupled with decentral- 74 This case study considers an approach to expanding lending to agricultural ized customer services providers to fill that gap in order to sectors through the use of innovative techniques and processes facilitated by increase access to these essential financial services. technology. The case is not coffee specific; however, it is relevant in showing how technology and alternative operating models for delivery of financial services might be used to deliver loans to rural clients currently outside the reach of the Sub-K is a subsidiary of BASIX and provides residents formal banking sector. of rural, urban, and semi-urban areas with a mobile A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 51 technology-based transaction platform for access to » Cost-effective for the consumers: banking beyond services. The financial services include savings, micro- the branch at the retail stores pensions, micro-insurance, National Rural Employment » Economically viable for the banks: Costs involved Guarantee Act (NREGA) and other government pay- in serving a consumer for low cash and large vol- ments, money transfers, micro-credit, utility payments, umes are significantly reduced and prepaid mobile top-ups. Sub-K has established part- » Increase in value for the retail store owner by be- nerships with eight nationalized banks in India to extend coming a business correspondent financial services using business correspondents in under- » Technically feasible in terms of ease of operations, served markets. Currently, Sub-K has operations in more use of simple technology, and uniform quality of than 200 districts providing services on behalf of Syndi- service cate Bank, Ratnakar Bank, Axis Bank, ING Visa Bank, Bank of India (BOI), Societe Generale, Karnataka Bank, APPROACH and KBS Bank. In total, the program currently comprises Sub-K, in collaboration with financial institutions, has 3,000 outlets with more than 600,000 customers. reached a majority of the customers by selecting and train- ing retail shop owners to serve as business correspondents ACTION (or “Live ATMs”). It trained correspondents in financial Sub-K’s business model enables customers to conduct service provision and marketing in order to provide them financial transactions through its allied business correspon- the capacity to effectively deliver services to its custom- dents. This service delivery model provides a wide range ers. In order for the business correspondent to complete of customer-friendly services in an accessible, affordable, end-to-end customer transactions, they have been trained secure, and transparent manner. The correspondents pro- and provided, at their cost, a micro-ATM kit, which is vide real-time, personal financial tools and services at a a combination of mobile phone and a Bluetooth hand- much lower cost estimated at 70–80 percent of the current held printer. Sub-K facilitates all the transactions using costs associated with “smart cards” at a rural bank branch. either an interactive voice response technology that uses To that end, Sub-K serves as an aggregator of existing voice biometrics for speech verification and recognition financial products and delivers these to the consumer while or fingerprint authentication, making the delivery of the collaborating with banks to create new products. Sub-K’s products and services secure. To ensure the business cor- overall aim is to provide financial transactions at a cost of respondents were effective financial service agents, Sub-K Rs10 (Rs = Indian rupee) for transacting amounts below had to: (a) make settlements online with real-time transac- Rs1,000, expanding the opportunity for financial inclusion. tions; (b) eliminate cash management by providing a float Key to achieving this goal is the use of a mobile-based plat- fund to each correspondent outlet for conducting transac- form with technology innovations supported by personal tions; (c) eliminate expensive and offline smart cards; and identification numbers, voice recognition, and fingerprint (d) establish the locations of business correspondents as identification to effectively and safely deliver the products permanent entities in their communities. and services to under-served communities. The key value proposition of Sub-K includes: SUB-K AND LENDING » One-stop shop for financial and non-financial Although to date lending has not been one of the central services services facilitated through the Sub-K network, arrange- » Interoperability with multiple banks and business ments have been made to expand its application to credit. correspondents Sub-K is now being used for lending in partnership with » User friendly: voice authentication and interactive YES Bank and Coastal Bank, and these partnerships will voice response subsequently be extended further to other banks. Lend- » Innovations in delivery mechanism and technology ing will be conducted through the bank accounts of the » Robust and scalable business model individual customer or by capturing transactions through » Low capital expenditure and operating expenditure the Sub-K technology platform, which will also be used to 52 Risk and Finance in the Coffee Sector authenticate customers. This, unlike traditional lending, tion to all customers regardless of location and provided would allow: timely back-office support. Even so, there remain chal- » Real-time capturing of transactions (disbursement lenges to reaching customers in rural and remote areas. and recovery) Many of these are the same challenges that confront tra- » Reduced transaction costs for banks as well as non- ditional lending approaches, such as dealing with govern- banking finance companies ment officials at the village level, and coping with fidelity » Lending to remote areas using technology that pro- risk and cash-handling risk. motes inclusion of rural borrowers » Productivity increases by reducing transactions costs CASE STUDY 9: FARMERS’ The cost of lending with Sub-K is estimated to be half of ACCESS TO CREDIT the cost for existing methods of lending. It is hoped that THROUGH THE USE OF these costs can be reduced further through additional pro- ductivity enhancement and value addition from utilizing CREDIT GUARANTEE of a common platform. For these loans, lending will take SERVICES: EXPERIENCE place through referral mode using agents at village level. OF COFFEE FARMERS IN However, while repayments will take place at agent out- lets using Sub-K technology on real time basis, customer ETHIOPIA AND RWANDA registration and verification will need to be conducted at INTRODUCTION bank premises. This case study examines the CFC/ICO/Rabobank Foundation/Rabo Rural Fund financing project that is currently ongoing in Rwanda and Ethiopia. It highlights INITIAL OUTCOMES AND how one program implemented in two countries can LESSONS LEARNED have significantly different outcomes, even when project While the lending component of the Sub-K work cannot be designs are almost identical. This case focuses on how cof- evaluated yet and is only in the initial stages, there are some fee sector enterprises were provided with financing from lessons related to the use of technology for extending finan- commercial banks facilitated via the provision of a guar- cial services from the work of Sub-K and the use of business antee facility. The mixed outcomes from this project high- correspondents. Sub-K has devised a promising solution to light the need to both consider national differences, in the “point of recovery” concept suggested by the Reserve terms of the enabling environment within a country, and Bank of India, proving its model, through innovative tech- the need to ensure high quality implementation, tailored nologies, can reach the unbanked rural population where to the local environment, to facilitate positive outcomes. there are no branches available. The Sub-K approach has In short, the case demonstrates that any party implement- addressed financial service process gaps through its use of ing a project aiming at improving access to finance for the a real-time information-processing framework. Routing coffee sector must ensure that project implementation is transactions through a bank account has also helped to fos- tailored to the national, regional, and local contexts. A ter savings habits among customers. Despite these successes, high-quality project design is insufficient to ensure results. some process delays and technology issues still need to be addressed, illustrating that while many additional rural clients have been reached and served, challenges remain. BACKGROUND INFORMATION Until such time that the Sub-K lending component is fully The project in question was designed to assist coopera- evaluated, a comprehensive understanding of the efficacy tives in accessing finance in a sustainable way, including of the program will not be available. working capital loans to enable the purchase of coffee cherries and long-term loans for investment in equip- Sub-K had provided the operational strength to approach ment and investment in infrastructure. This is turn would customers in all the locations. It has allowed communica- enable the cooperatives to improve coffee quality and A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 53 raise the incomes of their coffee growing members75. The » High transaction costs for processing and monitor- mechanism for the expansion of finance was the provision ing small loans of a guarantee service for local banks that were lending » Weak farmers’ organizations, restricting the ability to the sector. The project was implemented in Ethiopia to lend to aggregated groups of farmers and Rwanda, which are both coffee-producing countries. » Lack of straightforward, efficient loan recovery on The project is ongoing, but initial results demonstrate default notably poorer results in Rwanda (with fewer loans made » Inadequate understanding of the coffee sector by and higher defaults) than in Ethiopia, despite the project the banking industry design and implementation being almost identical in both countries. The constraints identified were largely similar to those highlighted in an earlier study jointly undertaken by the The project derived from a three-year pilot project on CFC, ICO, and the World Bank in 2000.76 improving coffee quality in East and Central Africa through enhanced primary processing practices. The PROJECT DESIGN: INTRODUCTION OF original project aimed to demonstrate good practices for A CREDIT GUARANTEE SCHEME TO post-harvest processing of coffee, enabling farmers to pro- ACCOUNT FOR LACK OF COLLATERAL duce higher quality coffee, generate higher income, and Project research showed a lack of collateral is a major con- improve their livelihoods. To help achieve these objec- straint to borrowing by farmers for investment purposes, tives, equipment for small-scale coffee washing stations— with most banks requiring collateral valued at a minimum such as pulping machines and raised drying beds—was of 100 percent of the loan amount in addition to interest. As delivered to participating farmers. The marketing of such the project decided to utilize a credit guarantee scheme these high-quality coffees was also organized with tech- to address this barrier, enabling banks to use the guarantee nical assistance provided to build the capacity of farm- partly as an alternative to traditional forms of collateral. ers’ organizations. The original pilot project concluded in 2008; however, at the project closing workshop, it was felt The project drew up a credit guarantee scheme based on a that a new initiative was needed to consolidate the positive risk-sharing agreement between the CFC and Rabobank results achieved and to assure the sustainability of good Foundation to cover half of any losses incurred through post-harvest practices developed throughout that initial the lending made to farmers as part of this project, with project. Specifically, the new project would focus on ena- CFC and Rabobank Foundation contributing in excess of bling farmer cooperatives to access finance to fund the US$3 million. The guarantees were provided through the purchase of coffee cherries and investment in equipment Rabo Rural Fund, who has acted as the fund manager. to improve the quality of their coffee. In addition to the guarantee, Rabobank International Advisory Services (RIAS), was contracted by CFC to pro- During project design it was determined that banks in vide technical assistance to the banks to educate them in both countries perceived lending to smallholder produc- lending to the coffee sector and to provide technical assis- ers to be unattractive due to perception of high risk and tance to coffee cooperatives on corporate governance and cost, with relatively low risk mitigation opportunities. Spe- financial literacy. cific issues identified included: » Smallholder farmers being unable to provide via- ble collateral; in the case of Ethiopia, this was fur- PROJECT ACTORS ther aggravated by a land ownership policy where Public Sector Project Management farmers do not own their land In Ethiopia, the Ministry of Agriculture and the Rural Development, Extension, and Marketing departments 75 Sustainable Credit Guarantee Scheme to Promote Scaling Up of Enhanced Processing Practices in Ethiopia and Rwanda (Project CFC/ICO/48), cur- rently being implemented by Centre For Agriculture And Biosciences Interna- “Marketing and Trading Policies and Systems in Selected Coffee-Producing 76 tional (CABI) and Rabobank. Countries,” Country Profile, February 2000; CFC/ICO/04FA. 54 Risk and Finance in the Coffee Sector managed the project on a day-to-day basis, while in selected eligible borrowers in collaboration with project Rwanda the National Agricultural Export Development management. The size of the potential guarantee was Board provided this support. US$2.25 million. At commencement, 42 cooperatives were selected to participate in the scheme, and their appli- Project Implementation cations were submitted to the Cooperative Bank of Oro- Centre for Agriculture and Biosciences International mia for assessment. In Rwanda, the size of the potential (CABI) was the project executing agency with primary guarantee was US$1.35 million. At project commence- responsibility for project coordination, supervision, and ment, 20 cooperatives were selected and their applications monitoring. In addition, CABI led the work on agro- were sent to BPR for assessment. nomic aspects for cooperatives and market access for cooperatives. Supporting Project Activities for Improving Access to Finance TECHNICAL ASSISTANCE: BANKS The project implemented a series of activities to improve AND COOPERATIVES (FINANCIAL AND the ability of the banks to lend and the ability of the ORGANIZATIONAL MANAGEMENT) selected candidates to borrow. Key activities included: RIAS provided technical assistance to the banks partici- pating in the project, building their capacity to under- (1) Assessing the existing system used by the banks to stand and lend to the coffee sector. RIAS also provided advance and recover loans from their coffee sector clients. technical assistance to cooperatives on financial literacy An effective loan system requires an efficient loan appraisal and corporate governance, with additional support from system that takes into account the unique characteristics CABI. of the crop for which the loan is sought. Therefore, infor- mation was collected from banks on their criteria for dis- Commercial Banks bursing and recovering loans related to coffee, gaps were The selection of banks to participate in the program was identified, and improvements suggested and implemented made during project design, with Cooperative Bank of by the banks. To facilitate this work, information was Oromia (CBO) selected in Ethiopia and the Banque Pop- gathered from the potential cooperative borrowers about ulaire (BPR) in Rwanda. Their selection in this pilot phase factors that could contribute impact their ability to repay was influenced by their existing link with Rabobank77 and their loans (key factors included: inadequate management their focus on the agricultural sector and the availability and leadership of cooperatives, lack of financial literacy, of a network of branches in rural areas. The two banks and poor transparency). The banks utilized this improved committed to increase financing to the coffee sector by credit assessment process when determining whether to utilizing the guarantee scheme. Even with the guarantee lend to the cooperatives seeking funds. arrangements, the banks retained an obligation to lend responsibly utilizing prudential banking practices, relying (2) Identifying and addressing challenges to lending to on their existing lending policies and procedures in assess- cooperatives and addressing these challenges. Surveys con- ing and approving the credit facilities. ducted at banks and at cooperatives identified some key barriers to lending: a) banks were reluctant to take on the Borrowers, Beneficiaries additional costs associated with administering many small In both Rwanda and Ethiopia, borrowers included business loans to coffee cooperatives; b) banks perceived farmer cooperatives, small- and medium-sized enter- the business management skills of the cooperative lead- prises, and large-scale commercial farmers active in coffee ers to be weak; and c) cooperatives struggled to complete production, processing and trading. In Ethiopia, lenders the documentation required to apply loans. As a result, the project implementation team (CABI and RIAS) developed a capacity-building program for cooperatives to improve 77 Cooperative Bank of Oromia (CBO) is a partner bank of Rabobank interna- tional. Banque Populaire du Rwanda (BPR) is a partner of Rabobank, which their management and financial literacy skills and enhance itself holds an equity stake in BPR. their attractiveness to banks. The capacity building A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 55 included workshops covering various organizational and Cooperatives with no previous history of accessing loans financial topics, and technical support to cooperatives in directly (having previously relied on parent cooperatives) respect to preparation of business plans and in support of now feel more empowered technically to access loans inde- their ability to meet bank lending requirements. pendently. These achievements were made possible by the capacity-building and education activities implemented in In addition to the work to bolster the cooperatives’ finan- the country since the start of the project. In addition to cial management skills, the technical assistance provider the capacity building at the cooperative level, the guaran- also ensured the provision of agronomic capacity building, tee scheme provided support to CBO in order to lend to including seedling preparation and planting, coffee main- clients that historically would have been excluded due to tenance (pruning, organic and mineral fertilizer applica- lack of collateral. tion), pest and disease control, coffee extension services, and coffee processing. The goal was to improve both the With continued capacity building by CABI and RIAS, managerial and technical competence of the cooperatives. it is expected that by the end of the pilot phase of the project in 2016, the number of beneficiaries in Ethi- (3) Building the capacity of bank loan officers to lend to opia will increase substantially. However, it should be the coffee sector, and coffee cooperatives. RIAS organized noted that while the program has enabled new loans to training sessions for the bank staff in charge of lending be made for working capital purposes, no longer-term to farmers. This training involved educating loan officers loans were made for investment purposes, which was about the sector of its key actors so that they might better one of the original project goals. This highlights the understand the potential borrowers and gain an appre- continued challenges, even with a guarantee program in ciation of ways to assess their creditworthiness and make place, that hinder banks from lending longer-term funds more informed lending decisions. to clients for investment purposes. In the Ethiopian con- text, the monetary environment proved to be challeng- PERFORMANCE OF THE SCHEME ing due to a change in central bank policy which limited IN THE PARTICIPATING COUNTRIES the scope of commercial banks expanding lending to Ethiopia clients. CBO was established in October 2004 with the purpose of providing financing to primary cooperatives and as Rwanda such, already had significant experience with this sector. The guarantee scheme was launched in Rwanda with a The bank enjoyed a 98 percent loan recovery rate and selection process to identify eligible cooperatives. A set of had proven credit screening and monitoring processes minimum criteria for accessing loans were established by already in place. As stated, the purpose of the program BPR for cooperative selection and specified: a) the coopera- was to enable cooperatives that had previously lacked tive must show own funds equivalent to 50 percent of the the necessary collateral to secure a CBO loan to finally loan requested; b) evidence of market access in the form of become eligible for finance. a forward contract or letter of intent from a potential buyer; c) a good track record of management of washing stations Out of 42 cooperatives identified at the outset, 22 coopera- over previous years; d) acceptable financial performance over tives that complied with the criteria were selected to partici- the past two coffee seasons; requirement of security with a pate in the credit scheme, and templates and guidelines for value equivalent to 130 percent, considering the 50 percent the preparation of business plans were developed for these guarantee a residual security of 80 percent was needed. This cooperatives to apply for loans to finance the 2012/13 coffee could be in the form of fixed assets, personal guarantees of season. Working capital loans amounting to the equivalent members or off-takers. Even with the guarantee of 50 per- of over USD$700,000 were provided to 11 cooperatives cent in place, there was a significant requirement for any in Ethiopia under the credit guarantee scheme. All these borrowing cooperatives to prove their managerial and tech- cooperatives were receiving their loans directly from the nical business management competence and their financial bank for the first time in their history. sustainability. 56 Risk and Finance in the Coffee Sector During the 2011/12 coffee year, only three cooperatives Arguably, both Ethiopia and Rwanda share significant out of the 20 that applied were able to meet the rigorous constraints in cooperatives accessing lending. Both coun- selection criteria. These three cooperatives were provided tries have relatively weak cooperatives with poor mana- with total loans equivalent to US$365,000. However, even gerial and organizational skills. Both countries have fiscal with the rigorous selection criteria, all three cooperatives constraints that limit the scope of banks to expand their failed to repay their loans due to a severe drop in prices. lending and both experience the same challenges of This example showcases that creditworthiness and financial extreme price volatility in the coffee sector, which signifi- performance can be derailed by outside factors in spite of a cantly affects the performance of coffee sector borrowers. rigorous due diligence program and the provision of tech- However, the differences are also noteworthy. In Ethiopia, nical assistance in cooperative and financial management. the bank involved in the project has an explicit mandate to work and support cooperatives and was arguably more In the following year, only four cooperatives were able willing to provide flexibility in its lending requirements to prepare and submit acceptable loan applications. Out than BPR, thereby enabling more cooperatives to access of these four, only one cooperative met the criteria and finance. In Ethiopia, the support from the project imple- was provided with finance. The failure in Rwanda was mentation agency was much more proactive, with greater based on a number of factors, including: the poor cor- emphasis on marketing the project to cooperatives and porate governance and financial management of coffee securing their involvement. A final point of note is the cooperatives; limited capital and availability of collat- structure of the coffee sectors in both countries. The mul- eral; the inability of cooperatives to effectively manage tiple small-scale cooperatives in Rwanda, based around price risk (the failure to either hedge or to operate an washing stations, are often less robust than the primary effective back to back program of sales and purchases); societies in Ethiopia, which are linked to professional the competitive coffee landscape in Rwanda (with inde- unions. When shocks (such as price falls and spikes) occur, pendent actors arguably operating more professionally the cooperatives in Rwanda are much less able to com- than the cooperatives); and the inability of the bank to mand their members’ loyalty. process loans in a timely manner, delaying disbursement and further damaging the performance of the coopera- A key lesson from this project must be that projects cannot tives. In addition to the above issues, there was also a spe- simply be copied from one country to another, but rather cific challenge given there was no local CABI-style actor the local differences need to be adequately accounted for pushing the Rwanda program forward with cooperatives and the project structured and designed to accommodate (as was the case in Ethiopia). This hampered the partici- these differences. pation of the cooperatives in the program and reduced the number of creditworthy cooperatives requesting financing. On the other hand, CBO, established by cof- CASE STUDY 10: fee unions, had more experience with financing coffee INCORPORATING PRICE RISK cooperatives. MANAGEMENT INTO THE LENDING OPERATIONS Conclusion While the program design was identical in both coun- OF A TANZANIAN BANK: tries, it is obvious that the outcomes were very different. 2005–07 Ethiopia’s effort met with a measure of success in terms Objective: Protect lenders, bank clients, and of cooperatives receiving and repaying loans, while in cooperatives—especially those that announced preseason Rwanda few cooperatives received loans and there was prices to growers—against intraseason price volatility. a high rate of default. This raises significant questions regarding the enabling environments in each country and Response: Introduce tools for risk assessment and quan- whether a successful project to increase finance in one tification, and promote risk management through physi- country and be simply repeated in another. cal and financial risk management (hedging). A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 57 CRDB Bank (CRDB), based in Dar es Salaam, is a that its clients would be unable to repay these advances if large commercial bank. It was originally a state-owned prices fell sharply.80 rural development bank but was privatized in 1996 and has since become one of the largest retail banks in Tanza- To avoid having to curtail lending still further, in 2005 nia, operating across the corporate, retail, business, trea- CRDB introduced a risk management program called sury, and wholesale microfinance sectors. The bank was Kinga Ya Bei that was to provide greater protection to listed on the Dar es Salaam Stock Exchange in 2009 and the bank and improved flexibility to its clients. The pro- expanded to Burundi in 2012. At the end of that year, gram focused on risk quantification and assisting clients the total number of banking customers had grown to over in managing risk through market-based instruments. This 1.2 million. CRDB has a long history of lending to the program was also implemented for cotton clients. rural sector, stemming from its history as a rural bank and its desire to reach untapped markets. In 2012, lending to Approach. The approach taken was primarily capac- agriculture was 28 percent of the bank’s total loan portfo- ity building so that CRDB and its clients could acquire lio despite a decreasing emphasis on agricultural lending the technical skills needed to better manage the price risk due to sector risk (CRDB 2012). involved in buying coffee without immediately selling it (trading back-to-back or taking a long position). The goals As a result of the 2002/03 coffee crisis when prices were: fell considerably, CRDB faced significant default issues 1. Risk Assessment: Introduce a systematic approach from its coffee clients, primarily cooperatives, that had to risk assessment, enabling clients to understand when and been taking in coffee at prices that turned out to be well to what magnitude their business is or becomes exposed to above the prevailing market. Some clients were buying price risk by compiling daily position reports and marking coffee at fixed prices without knowing what the auction “to market.” sales price would be;78 that is, they were long and as Up to this point, most of CRDB’s clients neither such were fully exposed to price risk.79 Still other bank knew their “position” nor their market exposure clients were impacted by price fluctuations that arose and were often exposed to the vagaries of the in the time between when they would buy coffee from market. Capacity building was used to help clients farmers, mill the coffee, transport it, and then sell at understand when they became exposed to price the auction. risk; that is, when buying before selling (long) and when selling before buying (short). It also demon- Action. CRDB’s initial answer was to only lend against strated how small changes in price while exposed in-warehouse coffee by implementing a collateral man- could nevertheless create substantial losses. agement system under which borrowers could access 2. Physical Price Risk Management: Provide funds (up to a preapproved level) only after depositing cof- training to clients on physical risk management. fee into a predefined milling facility or warehouse. This One of the ways in which CRDB clients were coffee then became collateral for any lending, and, in encouraged to manage their risk was through the order to limit its exposure to price risk, the bank would use of physical coffee transactions. At the time, only advance a percentage of the estimated value. If direct export licenses were being introduced in CRDB pitched its advances too low, then clients could not Tanzania to allow sellers to bypass auction for operate; yet keeping them close to prevailing price levels some of their coffee. Capacity building was pro- remained extremely risky. Even though this provided some vided utilizing different approaches to physical limited protection to the bank, it could not account for price risk management and concentrating on the extreme price movements, leaving it exposed to the risk 80 Moshi coffee auction prices would fluctuate considerably, at times contrary to global market developments and could (and did) drop sharply from one week to 78 Most coffee was being sold through the weekly Moshi coffee auctions. the next. This basis risk; that is, that the price for Tanzanian coffee moves con- 79 Long refers to buying coffee now for later resale, while short positions involve trary to the global market, cannot be hedged nor could it be quantified because selling coffee forward to be purchased later. of clients producing varying qualities of coffee. 58 Risk and Finance in the Coffee Sector use of coffee contracts and relationships with oth- enabling their clients to use the bank’s risk management ers in the coffee chain in order to minimize the services as they felt were needed. Very small numbers time between the purchase and sale of coffee and of clients did utilize CRDB to purchase hedges through vice versa; that is, trading back-to-back whenever options on international markets, but rising prices caused possible as a way of limiting risk for both client their interest to wane. Therefore, while part of the objec- and lender. tive at the outset of the program (to allow clients to access 3. Managing Price Risk through Hedging: market based price risk management instruments) was Provide access to financial price risk management mecha- only partially achieved, CRDB became much better at nisms and prepare clients to utilize these when needed. assessing their borrowers’ exposure to price risk by assess- CRDB built an in-house capacity for this pur- ing break-even levels, analyzing their positions, and mark- pose and provided its clients access to futures and ing these to market. options through a commodities broker. Prior to this, most, if not all, of these domestic operators LESSONS LEARNED had no such access. CRDB provided training on Demand for risk management is based on mar- the different alternatives for these instruments and ket conditions. The experience with CRDB demon- when their use would be considered appropriate. strates an important lesson about the opportunistic nature of many coffee clients. Most viewed risk management as In addition, the program focused on training CRDB staff a one-off intervention and only became really interested so these could build capacity among the bank’s clientele. when market prices fell, as happened during the coffee Clients were encouraged to include risk management in crisis. However, as prices subsequently improved, their their everyday operations and not to treat this as a sep- interest in price risk management declined once more, the arate activity. Similarly, CRDB staff was encouraged to perception being that prices would remain high. Essen- treat risk assessment as one of the core components of tially, clients often did not see the need to invest in risk lending, meaning that risk management should be one of management on an ongoing basis. the key lending criteria and should be part of a borrower’s normal operations. CRDB’s clients were encouraged to Risk management is dynamic and needs to be begin managing their risk as soon as they began purchas- done on an ongoing basis. The risk assessment and ing coffee to help protect the global price level on which quantification portion of the work done was applicable their purchases prices were based. to a large number of businesses. Many of CRDB’s cli- ents did not have these skills and therefore they were often Outcomes. While many clients integrated the ideas of taking on risks they could not quantify. Training in these risk assessment and physical risk management into their areas allowed clients to begin identifying price risk in their operations, CRDB did not always insist that clients imple- business. It also allowed them to identify how it changed ment risk management as a prerequisite of lending. Those on a daily basis, allowing them to manage risk through the from CRDB working with clients therefore tended to view most appropriate strategy. financial risk management much more opportunistically than systematically, particularly as coffee prices rose stead- Holistic risk management. One aspect that became ily in the years following the program’s inception, mak- clear was the need to focus on holistic risk management ing it difficult to quantify the actual results. They also rather than on a specific financial risk management regarded the exercise as being quite expensive, with prices instrument, that is, options.81 Risk management strategies for put options at the time historically around 5 percent to 8 percent to protect at current market levels. 81 Options vs Futures. Options are ultimately a more expensive means of hedging price risk exposure. With margins tight in the coffee sector, the costs associated CRDB staff did become technically competent in discuss- with options did not seem reasonable to most clients. While providing credit ing risk management and assisting clients in better man- guarantees to support the use of futures contracts would have reduced the cost aging their risk by providing the necessary training and of hedging, this would have increased the risk of the program. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 59 would need to vary by client type, since work with CRDB in CRDB’s agricultural lending practice. To that end, showed that there is no one-size-fits-all solution for risk CRDB has been looking at the option of hedging the management. Solutions need to be customized, unique, whole commodity portfolio (cotton, coffee, and so on) and and reflective of existing market and trade conditions. In passing the costs to clients. CRDB is about to establish a order to do this, clients must quantify their exposure to dedicated Commodity Price Management desk following risk on an ongoing basis. the recommendations of the International Finance Corp (IFC) from its recent review of CRDB. In addition, IFC Risk Preference. Not all clients were interested in have approved a short term credit line to CRDB dedi- managing their risk. Some instead preferred to remain cated to a Global Warehouse Finance Program with con- exposed to price risk in order to potentially have a higher cessional pricing. payout in a given year. They did not want to trade the potential upside for locking in small margins, especially when prices were low. When prices are weak, clients CASE STUDY 11: CÉDULA might feel they are locking in a loss and are paying for DE PRODUTO RURAL: A an insurance they will not use. Yet even if prices are low, TRADABLE RECEIPT IN it is entirely possible for them to fall still further. Banks BRAZIL may still insist on cover being taken and, as such, put Objective. Provide an alternative to government financ- options are attractive as long as prices remain at reason- ing for agricultural producers and agribusinesses, includ- able levels. They help provide a price floor but they have ing those working in coffee. to be put in place before, not after, a market falls. And finally, some clients in fact considered currency risk the Response. Banco do Brasil introduced a tradable receipt greater risk. called the Cédula de Produto Rural (CPR) to make it easier for producers and agribusinesses to access private Incentives. In implementing this program, it was criti- financing. cal that CRDB management made risk management an operational priority. Because there are costs both in Background. Since the 1980s the agriculture sector, terms of time for risk quantification and money in terms which represents 40 percent of total Brazilian exports, of hedging instruments associated with risk management, has contributed to the economy by keeping food prices CRDB staff had to see implementing this program with stable through increased production, and by bringing in clients as a major component of their performance evalu- billions of export dollars. Figures 5.19 and 5.20 compare ation. However, given all the other lending requirements the percentage contributions of key agricultural products and competition in the sector, banking staff and manage- to Brazilian exports in 2002 and 2012. Over this time, ment did not obligate clients to participate in the program; the coffee market’s share of Brazilian exports has grown it was instead provided on an optional basis, probably in from 5 percent to 7.6 percent. Figure 5.21 shows the value part because the program was not only new but also as yet of Brazilian coffee exports; it points to the decline in the unproven. value of exports between 1997 and 2002 that accompa- nied the international coffee crisis as well as the subse- SITUATION TODAY quent recovery from 2003 to 2011 (even in spite of the CRDB has been in discussion with additional brokers financial crisis in 2008–09). The value of Brazilian coffee since the expiration of its contract with those involved in exports is directly influenced by the international com- the original program. So far, the quotes for brokerage ser- modities prices for coffee and as well as demand for coffee vices have been out of the scope of CRDB so the bank in evolving coffee markets. is still exploring different options. However, despite not having an active relationship with a broker, commodity Coffee producers and agribusinesses need access to credit price risk management has been a key area of concern in order to carry out activities such as land preparation, 60 Risk and Finance in the Coffee Sector FIGURE 5.19. AGRICULTURAL EXPORTS FIGURE 5.20. AGRICULTURAL EXPORTS PERCENTAGE OF TOTAL 2002 PERCENTAGE OF TOTAL 2012 Soybean grains Raw sugar Chicken Soybean meals Soybean grains Raw sugar Chicken Soybean meals Cereals Beef Coffee Corn Cereals Beef Coffee Corn Cellulose Tobacco White sugar Cellulose Tobacco White sugar 3.7% 4.3% 4.1% 4.1% 12.7% 6.3% 23.2% 4.9% 7.0% 1.1% 4.7% 7.6% 5.0% 13.3% 5.8% 7.6% 4.8% 8.6% 9.6% 9.2% 8.8% 1.1% Source: SECEX/MDIC. Source: SECEX/MDIC. FIGURE 5.21. EXPORT OF COFFEE IN BRAZIL IN US$ BILLIONS (CONSTANT PRICES, 2013)* 10 9 8 7 US$ billions 6 5 4 3 2 1 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: SECEX/MDIC (http://aliceweb.desenvolvimento.gov.br/). Ministry of Development, Industry and For- eign Trade. *NOTE: For 2014, the value reflects the three months through March. fertilizer, and field maintenance. But while some traditional roeconomic shifts within the country and the impacts of lending is available through banks and other financi- unsustainable government support combining to bring a ers, these channels are not always sufficient. Before the halt to this subsidized credit. In turn, by the early 1990s 1990s, credit to agricultural producers in Brazil was avail- the agricultural landscape for credit began shifting, as the able from the government at subsidized terms, with the government was no longer providing this credit to pro- total value of all loans peaking in the 1970s (figure 5.21). ducers at the levels available over the previous 50 years. Government policies during this period favored import By the early 1990s, rural credit policies had collapsed and substitution and guaranteed price minimums for agricul- producers began accumulating significant debt. Eventu- tural products while also providing credit for production. ally, the government tried to create conditions for new However, the 1970s and 1980s brought changes as mac- credit instruments that would allow private markets to A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 61 FIGURE 5.22. TOTAL RURAL CREDIT SUPPLIED BY THE NATIONAL RURAL CREDIT SYSTEM 180 160 140 120 BRL billions 100 80 60 40 20 0 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Brazilian Central Bank (www.bcb.gov.br). finance agriculture.82 One of these new credit instruments had interest in the delivered product. This gave rise to the was the Cédula de Produto Rural (CPR). financial CPR in 2000. The financial CPR did not require the buyer to take receipt of the product, which opened the Action. When it was created through legislation in 1994, CPR to essentially any financer. the CPR represented one of the key innovations that arose to meet the demand for production credit by producers in The overall goal of the CPR program was to provide a Brazil. It was hoped at the outset that it would allow pro- viable credit alternative to producers who could no longer ducers to tap into new capital bases when accessing credit. effectively tap traditional credit lines, as well as an addi- This new program was championed by the Government tional credit alternative those who could. The specific of Brazil and has been supported heavily in its evolution objectives of the CPR were: by Banco do Brasil. » To finance production through early sales of the product The mechanism was designed to be simple and straight- » To guarantee the supply of raw materials through forward. Producers and cooperatives could issue a CPR in early sales of agro-industrial production return for finance of the amount matching their product, » To sell inputs through via barter operations, which the issuer was obligated to deliver on the negotiated through the exchange of inputs for farm produc- expiration date. Given the physical CPR required deliv- tion by companies dealing in inputs ery, it limited the buyers’ market for the CPR to those who » To provide alternative investments for investors and investment funds 82 Sousa and Pimentel (2005) argued that, “Brazilian agricultural policy also APPROACH has experienced a significant transformation that began in the seventies. Until The CPR is a bond product that was developed to pro- that time, the policy model was based on a highly protected economy, was designed for the substitution of imports, had an abundant subsidized supply of vide access to credit for working capital for producers credit, and used minimum price guarantees for commercialization. The fiscal and agricultural businesses. The CPR essentially creates insolvency of the State and the economic instability that marked the eighties, loan collateral out of the underlying product or livestock. however, lead to a near collapse of the rural credit policy at the beginning of Sellers of bonds are typically agricultural producers or the nineties. The failure of that model of credit, associated with the rapid and unplanned economic opening of the nineties, culminated in a major crisis in the processers, while buyers of these products can vary from agriculture sector” (p.4). financial institutions to investors. As these products are 62 Risk and Finance in the Coffee Sector tradable or able to be settled financially, it deepens the liquidation of the contract. Instead of delivering pool of possible credit providers to the agricultural sector. the produce to the buyer of the bond, the bond CPRs have a unique legal nature distinct from traditional issuer (producer) would sell the agreed output and agricultural finance; their terms are transparent and they settle the bond with cash. The cash would be equal are transferable. Disputes surrounding CPRs are often to the amount borrowed plus an agreed upon in- settled within 24–48 hours, making them appealing to all terest rate. This greatly expanded the number of parties (FAO 2011; World Bank 2005). parties interested in purchasing the CPR, particu- larly as the CPR interest rates were often higher The CPR basically takes three different forms: than for other instruments. 1. Physical—The physical CPR is a bond that can 3. Cash settlement based on futures prices— be sold by a producer. This bond requires that The final evolution of this product has been the the producer ultimately deliver an agreed upon cash settled CPR, indexed to a futures contract. amount of output or livestock of a specific qual- This was created by Banco do Brasil and allowed ity to a specified location on a particular date. cash settlement based upon a mutually agreed ref- Because the bond specifies that amount and qual- erence price. The reference price or index needed ity to be delivered, any deviation from the terms to be transparent, that is, taken from a publicly will result in a discount or premium payment at available and recognized source such as the Bra- the time of delivery. Physical CPRs can also assist zilian futures contract price or an external accept- producers in managing price risk. Given that ed published price index. Settlement is based on the sales price of the physical product is directly the price at the settlement date multiplied by the linked to the value of the bond, producers need agreed quantity. not worry that prices will fall after they have sold the bond and they would therefore be unable to OUTCOMES repay the credit. Instead, the value of the bond The CPR has proven to be a viable alternative credit instru- is directly linked to the value of the delivery. The ment for producers in Brazil. The CPR’s success is evident physical CPR was the first product introduced in the increasing values of negotiated CPRs observed until (originally for soybeans) and was established and 2009 (before the financial crisis), in addition to its wide regulated by Law 8929 of August 22, 1994 (Sousa acceptance by various economic agents as a normal means and Pimentel 2005). Sales volumes have increased of operations. Since its introduction, Brazilian producers since it is introduction and it has become one of have extensively relied upon the CPR when seeking pro- the most commonly-used tools for accessing pro- duction credit. While bank credit is sometimes available, duction finance in Brazil. CPRs have provided a viable and reliable alternative for 2. Cash settlement of CPR—Given the physical accessing production capital. It is difficult to determine CPR ultimately requires the bondholder to take exactly how widely the CPR has been used as many are physical delivery, some investors or other finan- negotiated privately. Some (primarily financial) issued ciers who wished to expand the types and classes CPRs are registered by CETIP.83 Coffee CPRs registered of their holdings and had sufficient capital to do by CETIP in 2013 corresponded to approximately 7.6 per- so were hesitant to enter this market. While these cent of total issued CPRs for a total value of $9.3 million CPRs were tradable, if an investor bought a CPR or US$4 million84 for financial CPRs. Figure 5.23 shows but could not sell it before delivery they would po- the breakdown of registered CPRs by agricultural product tentially have to take delivery (and in some cases they were prohibited to do this). This created a market for the emergence of a new CPR instru- 83 CETIP is a publicly-held company that offers services related to registra- ment that could be liquidated without physical tion, central securities depository, trading and settlement of assets and securities (http://www.cetip.com.br/Institucional/security-that-moves-the-market#!). delivery: the financial CPR. In February of 2001, 84 The Brazilian exchange rate ($/US$) in 2013 was $2.3420 according to The this element was added, permitting the financial Institute for Applied Economic Research-IPEA (www.ipeadata.gov.br). A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 63 FIGURE 5.23. FINANCIAL CPR REGISTERED FIGURE 5.24. FINANCIAL CPRS BY CETIP—2004–13—BRL REGISTERED ON MILLIONS (CONSTANT CETIP—2013 PRICES OF 2013) (% TOTAL) 1400 2.1 0.7 1200 19.0 1000 BRL millions 800 36.1 5.9 600 7.6 400 7.2 200 21.4 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: CETIP (http://www.cetip.com.br/) and authors’ elaboration. Bean Eucalyptus Cotton Cattle Coffee Sugar cane Corn Soybean in 2013, with soybean (36.1 percent) and corn (21.4 per- Source: CETIP (http://www.cetip.com.br/) and authors’ elaboration. cent) accounting for the greatest value of CPRs issued.85 However, since there are costs to register a CPR, there Research and interviews with producers and cooperatives is also a stock of unregistered, primarily physical, CPRs provided additional evidence as to the CPR’s role, which (Pimentel 2009). As a result, there are no robust data avail- seems to vary based on the size of the borrower and the abil- able on the use of CPRs relative to other types of credit. ity of that borrower to access credit from the government. However, people who work in the Brazilian agribusiness While the CPR does serve (among other products) to provide sector estimate that CPR represents around 40 percent a private credit alternative, significant amounts of funding in of the finance for agriculture. The CPR is one of a num- Brazil still come from government sources. According to the ber of agribusiness securities in Brazil that have been Brazilian Central Bank Rural Credit Statistical Yearbook, federal estimated to total 54 percent of the formal rural credit government banks (including Banco do Brasil) supplied 54.2 supplied in 2013 (Wedekin 2013).86 There was a lower rate percent of official rural credit in 2012, while private sector of default on CPRs In the credit market in Brazil (espe- financial institutions only supplied 32.5 percent.87 cially for financial CPRs), pointing to the model’s sustain- ability and its low risk (Almeida and Zylbersztajn 2012). Coffee cooperatives provided the most insight into the specific role of the CPR in coffee lending; they play an important role in the coffee supply chain (storing, mar- 85 Despite its success, the CPR market hit a turning point in 2009 as a result of keting, processing, economies of scale for input pur- the international financial crisis. The crisis reduced CPR usage by trading com- panies. This is evident in the example of soybeans in the state of Mato Grosso chases, and negation) (Bialoskorski Neto and Souza According to Pessôa (2012), soybean funding from 2007–08 was composed of 2004).88 Accordingly, cooperatives were able to provide producers’ own capital (6 percent), banks (12 percent), input firms (32 percent) and trading firms (49 percent). By 2010–11, those shares changed to: produc- ers’ own capital (25 percent), banks (19 percent), input firms (30 percent) and 87 The other credit suppliers were the state public banks (3.5 percent) and rural trading firms (26 percent). credit cooperatives (9.9 percent). 86 The agribusiness securities were created to provide sector finance through pri- 88 Cooperatives store, process, and market (and sometimes roast) a considerable vate resources. There are five types of agribusiness securities admitted to registration amount of production. Cooperatives also provide greater market power to pro- and/or trading on Brazilian Futures Market and Commodity Exchange: Sistema ducers, and reduced production costs through economies of scale. Without the de Registro de Títulos do Agronegócio, Cédula de Produto Rural, Certificado de producers union, each producer would bear the full costs of planting, storing, Depósito Agropecuário/Warrant Agropecuário, Certificado de Direitos Creditórios and transporting, which would require significant investments. Working within do Agronegócio, Letra de Crédito do Agronegócio, and Certificado de Recebíveis cooperatives also allows inputs for planting to be carried out on a large scale and do Agronegócio (Source: http://www.bmfbovespa.com.br/home). often results in discounted prices for inputs. 64 Risk and Finance in the Coffee Sector perspective as to how and in what ways CPRs were being BOX 5.2. INTERVIEWING FARMERS ON used. Two coffee cooperatives in the state of Minas Ger- COFFEE FINANCING ais89 stated that the CPR is one of the most-used credit instruments for coffee producers in their region, and that To get a perspective on what access to finance and the role of the CPR means for those that work in the sector, producers usually prefer physical CPRs rather than the farmers were interviewed to learn more about the role of financial version. Usually, CPRs are negotiated directly the CPR. One of these interviews was conducted with with the cooperative so there is little bureaucracy and a producer in the state of São Paulo. His farm produces the resulting deal has lower costs than CPRs negotiated 1,500 sacks (60 Kg) of coffee on 44 hectares. His produc- under the terms of Bovespa-BM&F, which requires more tion is financed using his own resources. However, he esti- guarantees and product specifications. mated that 60 percent to 80 percent of coffee producers use some credit instrument (such as the CPR) and that, on average, producers finance 30 percent to 40 percent The choice between utilizing the CPR or traditional credit of the production in his region. This perception contrasts sources often hinges on the producer’s output. Large pro- with the results mentioned by Saes et al. (2008); in their ducers have more knowledge and channels to access pri- research, 98 percent of the producers answered that they vate funds for production,90 including CPR, whereas the use own resources, 44 percent looked for bank financing, small producers must rely on resources from the official and 20 percent turned to cooperatives. CPR was used by credit system. However, even small producers will utilize 17 percent, and government resources 10 percent. The CPRs if the producer has a debt with the bank and can- producer’s emphasis on the importance of cooperatives as a channel for producer credit was notable. The producers not get credit from the formal system. In that case, the usually issued a physical CPR to the cooperative, as the producer must get credit from some other source, such as latter has an interest in receiving the underlying product. a cooperative or input firm, by hoping that they accept a CPR. On the other hand, if the producer has no debt A second coffee grower that producing 800 sacks (60 Kg) across 45 hectares in the coffee producing state of Minas with commercial banks, particularly is the case of cof- Gerais financed 40 percent of his coffee planting area with fee producers, there is also the potential at times for the credit, mainly for operating expenses. He was introduced producer to access a cheaper official credit source called to the CPR market by his local Banco do Brasil agency, Fundo de Defesa da Economia Cafeeira (Funcafe). Based which guaranteed the credit operations for the producer on interviews with a few cooperatives, producers pre- to the holder of the CPR. This producer has utilized both fer the physical CPR and cash settlement of CPR than the physical and cash settlement versions of the instrument. When coffee prices are low, he believes the physical CPR is cash settlement based on futures prices, and estimate that more appropriate. One disadvantage of the physical CPR, it represents around 30 percent of the total credit used. according to this grower, is that the costs associated with the Some of the key factors influencing uptake by the coop- strict quality standards of the contract are all born by the eratives interviewed include: producers. He also emphasized the role of local coopera- » Transaction costs for the product tives in the CPR market. Despite the presence of the CPR, » Ensuring that the product meets the requirements if producers do not know how to access futures market of the physical CPR contract information or know how to use CPRs, they prefer the for- mal credit system, and its federally-mandated interest rates. » Other risks such as weather including frost and drought, which can cause a failed harvest91 Another approach to financing that has been attractive to farmers is supply chain financing through input sell- 89 Information gathered through interviews by telephone. ers. In this arrangement, input sellers provide all inputs 90 Although they also use resources from the official credit system. necessary to the crop, and the producers make a commit- 91 Ozaki (2008) reports the agricultural insurance system implementation has ment to deliver them an amount of product equivalent to been a claim for a long time in the Brazilian agricultural sector, whereas the the value of the supplied inputs.92 One producer stated current insurance programs to agriculture show strong signs of exhaustion. The author mentions that, “over the years, government risk management tools, such as, Proagro and some private insurance companies have had unsatisfactory 92 This analysis coincides with the results obtained by Rizardi (2007), who did inter- financial results” (p. 98). views in the state of Paraná with producers, cooperatives, and agribusiness firms. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 65 that he preferred this type of negotiation to the physical amount of credit supplied by the formal system (which CPR because of the higher interest rate and classification has controlled interest rates) has recovered the level standards associated to CPR. close to that observed in the past; some producers pre- fer this credit channel as the proceeding to get credit on this way is less bureaucratic and the risk is relatively LESSONS LEARNED lower than the other options. In this context, CPR still CPR was an important instrument of credit created in time is an attractive and widely-used instrument. However, of formal resources scarcity for agriculture in Brazil. The this research verified some constraints related to CPR: emergence of the CPR helped expand the market for rural some producers report that it has been expensive and credit in Brazil, allowing for greater participation of private bureaucratic relative to other credit options (that is, the funds in the financing of agriculture. In addition, the CPR formal credit system and exchange input negotiations). was successful in the creation of a transparent business envi- Some producers consider that the negotiations with ronment; a view reinforced by a decline in default rates. CPRs over lower costs (reduced interest rate) are more One study that evaluated CPR as an alternative credit for bureaucratic, leading them to prefer accessing finance coffee producers in the state of Paraná for the years from from input providers. 2001 to 2006 concluded that CPR was very competitive Farmers still see the CPR as an important instrument of relative to other credit sources in terms of cost. However, credit, although compared with previous periods there are the interest rates associated with CPR experienced enor- now other competitive sources of credit. Some farmers, mous variation, which increased the risk associated with especially small farmers, can access other publicly sup- taking a CPR. As a result, the author concluded that the ported sources of affordable credit, while for large farm- ideal financing option for producers is the use of official ers, opportunities related to agribusiness securities offer credit, complemented by the CPR (Ivanaga 2007). Unfor- additional sources of credit. Since the CPR in effect com- tunately there is little information about the amount of petes with other credit instruments, it is perceived by some private credit negotiated among producers, cooperatives, that improvements could increase its competitiveness, and inputs firms, which makes it difficult to get a good pic- such as a reduction in bureaucracy and red tape (from the ture of the utilization of these different instruments. The producers’ perspective)94 on CPR issues and a reduction information available for CPR transactions is limited to in the financial costs. registered CPRs, which underestimates the market, espe- cially for the physical CPR. There is no central system to register all CPRs issued by the producers, which creates CASE STUDY 12: COMRURAL asymmetric information about the total credit captured HONDURAS—CROWDING among producers, banks, and others economic agents. 93 IN COMMERCIAL BANKS The Brazilian credit market is more diversified than in THROUGH MATCHING previous decades in which credit was concentrated on GRANTS public resources. On the other hand, since 2002 the INTRODUCTION The Honduran coffee sector accounts for almost 5 percent 93 Almeida and Zylbersztajn (2012) highlighted some benefits from CPR: It is of GDP and is the main export crop, totaling 17 percent an asset with lower risk; it has warranty and can be negotiated on financial of national exports. Honduras is home to approximately markets; and its characteristics promote lower risks, in turn reducing the chance of default. On the other hand, the authors mentioned certain disadvantages of 100,000 coffee farming families and the sector accounts CPR. The resources allocated by banks to buy CPRs compete with other eco- for almost 1 million jobs in maintenance, harvesting, nomic markets and the resulting higher internal interest rates lead the produc- ers with lower profitability to choose another credit source, which reduces the amount of CPR negotiated and the market attractiveness for investors. Addi- 94 To issue a CPR (under the terms of Bovespa-BM&F and to have the guaran- tionally, there is not a central system to register all CPRs issued by the produc- tee of Banco do Brasil) the producer should follow some requirement to register ers, which creates an asymmetric information about the total credit captured the contract, as with any other loan, and the product negotiated should conform among producers, banks and others economic agents. to the characteristics defined in the contract. 66 Risk and Finance in the Coffee Sector marketing, processing, and other related activities. Around alliances. The project (implemented by the Honduran 95 percent of coffee farmers are smallholders producing government and financed by the World Bank) works to less than 10 MT a year. Coffee is grown in the majority of assist producer organizations in building their produc- districts in Honduras, and is the main economic activity in tive value-chain alliances, and it also provides assistance several of them. As such, the health of the Honduran cof- in financing investment in producer enterprises so that fee sector is of tremendous importance to the country. For they can increase their productivity and generate higher example, the 2012/2013 harvest was badly affected by incomes for their members. Of specific interest is the role both a fall in international prices and an outbreak of rust. of COMRURAL in supporting coffee sector producer These factors combined to generate a fall of 21.4 percent associations and cooperatives in investing in their enter- in foreign exchange earnings (US$637 million) and the prises and supporting them in accessing private sector loss of around 100,000 jobs (Honduran Institute of Cof- bank finance through the use of matching grants. fee 2014). This case study shows how commercial banks, which have However despite its economic (and social) significance to historically shown a reluctance to lend longer-term to the Honduras, financing to the agricultural sector has con- coffee sector, can be encouraged and “crowded in” to the tinued to decline in recent years; in 2000, the share of sector by the provision of grants to support longer-term agriculture in total commercial bank lending was 21.6 finance to fund investment.96 In addition, it demonstrates percent; however, by 2010 this had fallen to 4.6 percent how the provision of technical assistance to cooperatives and declined further in 2011 to 3 percent. The financing and associations to assist them in drafting credible and of the agricultural sector is also concentrated across just a creditworthy business plans can facilitate these groups in few commercial banks with seven of the 17 banks operat- accessing finance from commercial banks. ing in Honduras providing 92.8 percent of total credit to the sector (Honduran Association of Banking Institutions OVERVIEW OF THE COMRURAL 2011). As such it is apparent that Honduran agricultural PROJECT producers, including coffee growers, face significant chal- COMRURAL operates through a competitive selection lenges in accessing financing from banks to support invest- process. The cooperatives and associations that wish to ment in their production. participate in the COMRURAL project have to prepare a business profile, outlining the current operations of the In addition to the lack of available bank financing, pub- cooperative while detailing their objectives and the ways in lic investment in agriculture in Honduras has also come which they will utilize the investment. A selection commit- under pressure. In 1990, the proportion of government tee evaluates the business profiles, with those selected then spending in the agricultural sector was 11 percent but this receiving technical assistance to prepare viable business declined to around 3.5 percent over recent years. Given plans, detailing how they will invest in their enterprises a decline in government funding, one might expect that and expand their productivity and revenues. The business farmers would be forced invest more in their enterprises plans contain information on all aspects of the proposed to make up for the reduction, however this requires access project including technical, commercial, social, environ- to finance, which is not readily available. mental, and financial viability, and risk management; all within the wider scope of the productive alliance within This case study considers the Rural Competitiveness Pro- the framework of the relevant value chains. For business ject (COMRURAL)95, which aims to increase productivity plans to be accepted by COMRURAL, they must demon- and competitiveness among organized rural small-scale strate that they are based upon a clearly defined market producers through their participation in productive opportunity, they address the training needs of the coop- eratives and associations, and that they will boost private 95 Details of COMRURAL can be found on the World Bank website: http:// www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2 008/05/22/000333037_20080522010139/Rendered/PDF/435390PAD0P10 96 The private sector provides a proportion of the financing of the business 117376B01OFF0USE0ONLY1.pdf. plans, with the public sector financing the remaining share. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 67 investment under a system of shared risk and mutual purely commercial terms and the banks obviously need benefits among the players. Throughout the project, the to assess the business plans and the proposals using their cooperative will continue to receive support and technical own rigorous credit risk assessment processes. Loans will assistance from business development service providers be used to finance with preference productive invest- under contract with COMRURAL. ment and the banks ultimately take autonomous decisions about requests for credit, based on market criteria, with banks determining the loan size and terms based upon FINANCING OF THE BUSINESS PLANS OF their assessment of the current and future payment capa- ASSOCIATIONS AND COOPERATIVES bilities of the participating cooperative. Similarly, interest The financing of the business plans is carried out through rates are determined between the bank and the coopera- a combination of private and public funds. COMRURAL tive and are market based. (drawing upon public funds) provides the cooperative with up to 60 percent of the total cost as seed capital financ- ing, which is non-refundable. Another 30 percent of funds COMRURAL AND THE HONDURAN come from a loan from one or more private financial COFFEE SECTOR partners, and the cooperative must contribute at least 10 The COMRURAL project was not coffee specific and was percent of total costs. As such the public funds are only available to cooperatives and producer associations across available if the cooperative can provide financing and has a wide spectrum of sectors. However, a number of the access to commercial bank financing. participants in the program were cooperatives involved in the Honduran coffee sector. This case study details a COMRURAL project involving a coffee sector coopera- USE OF RESOURCES/FUNDS tive and it demonstrates how the provision of a matching Participation by cooperatives in the COMRURAL pro- grant was used to encourage commercial banks to lend to gram also specifies how funds can be utilized. Just over 20 coffee cooperatives for investment purposes. percent may be allocated for use in technical assistance, training, and developing and strengthening relationships within the value chain, while around 70 percent should CAPUCAS AND THE COMRURAL be used for investment in infrastructure and productive PROJECT capacity (productive investment). Around 10 percent of The coffee cooperative Capucas is located in the com- the remaining funds should be utilized for project man- munity of Capucas in the municipality of San Pedro agement and operational costs. Productive investment de Copán, western Honduras. Land in the area is ideal refers to investments in washing stations, processing plants, for coffee production due to high quality of soils, good warehouses, fixed capital, equipment, buildings, machin- climatic conditions, and a topography suited to the pro- ery, technology, inputs, fertilizers, pesticides, fungicides, duction of high quality coffee. Capucas was organized as farm infrastructure, and technical assistance and training, cooperative in 1999 with 55 members and today has more among others. The funds received from COMRURAL than 700 members, mostly drawn from among small- and are in the form of grants and cannot be used to purchase medium-sized farms. The cooperative produces around land or to repay existing debts, that is, they must be used 181 MT of green coffee each year. The cooperative has to support new investments. focused its efforts on the production and commercializa- tion of micro lots of specialty coffees, which generate a The grant is dependent upon the cooperative or associa- substantial positive price differential, raising member tion receiving a loan from a commercial bank. Obviously incomes significantly over standard grade coffee. As such, the grant, alongside a robust business plan, is an incentive all coffee produced is separated according to the area of for a bank to provide financing, as investment is partially production, the type of soil, microclimate, topography covered by the grant amount; this is in effect a means of of the land, height and varieties, the state of maturation “crowding in” bank lending through the use of a non- of grain, and harvest time. This ensures the coffee can repayable grant. The loans are made by the banks on be marketed and sold as specialty micro lots based on 68 Risk and Finance in the Coffee Sector potential flavor and different characteristics according to extension services have made the plants more resilient to each of the variables described. pest and disease. However, Capucas has faced a significant challenge due Business plan implementation was reliant on accessing to the recent outbreak of rust infestation. A rust outbreak finance from a commercial bank (as per the COMRU- resulted in reduced yields and lower quality coffee, reduc- RAL program approach, a failure to secure commercial ing the specialty premium available (cupping quality had bank financing would result in the grant funds being fallen significantly). Capucas identified that the means for withdrawn). To this end, Capucas obtained financ- tackling rust was to invest in both coffee plant rejuvena- ing from Banco de Occidente at an annual interest rate tion and in extension services to ensure improved crop of 14 percent per year over a period of five years. The management, improved application of fungicides, and bank required collateral to secure the loan and the coop- (where appropriate) greater diversification. erative provided security through the land titles of coop- erative members. Currently, this is the only loan with a Under the COMRURAL program, Capucas compiled a local bank but they have credit lines and contracts with business plan focused on the improvement of production international importers that buy coffee in advance. In the and alleviation of the harm caused by the outbreak of past, Capucas had loans with other banks; for example, rust, and on ensuring the continued production of high- Banhcafe, Banpais, and coffee processor BECAMO, and quality, high-priced specialty coffee. The objective of the also with Banco de Occidente. However, its inclusion in project was to reinforce the production of specialty cof- the COMRURAL project and the resulting detailed busi- fee while ensuring social and environmental responsibility. ness plan and matching grant, helped secure a longer- This project built upon the history of sustainable coffee term loan over five years for investment purposes. The production at Capucas, which was already producing cer- loan from Banco de Occidente provides 43 percent of the tified coffee (Rainforest Alliance; Fairtrade; UTZ; Star- total project costs, 26 percent coming from Capucas’s own bucks Café Practices). Investments to be financed under resources and 31 percent from the COMRURAL grant. this program included the construction of a center for The total value of the project was US$1.24 million. organic processing of coffee, maintenance of farms, the purchase of a solar dryer, and expenditure on technical While Capucas had already established earlier relation- assistance and extension services for members. ships with commercial banks for loans, there are many examples from COMRURAL of coffee (and other) agri- The investment in the organic processing center enabled cultural cooperatives receiving loans for the first time the cooperative to start offering members attractively- from commercial banks, including longer-term loans. For priced non-chemical organic inputs. This investment is example, COCASJOL is a small Honduran coffee coop- speedily bringing benefits to the members: reducing pro- erative of just 200 members that had never previously duction costs, improving soils, spurring better practices to accessed finance. Through the COMRURAL project, deliver higher quality, and boosting the amount of organic it was able to access a five-year loan of approximately coffee sold, which also brings a significant price premium. US$300,000 that it utilized to on-lend to members for tree More and more members are moving their production replanting following the outbreak of rust and for assist- to organic coffee, with 85 percent of the production of ing members in diversifying into other less volatility com- Capucas now produced organically. modities (including honey). Capucas reports that the expansion of organic process- COFFEE SECTOR LESSONS ing has also assisted its membership in managing the FROM COMRURAL outbreak of rust. They report that the reduced costs of A comprehensive business plan, developed with techni- inputs generated by the organic processing have lowered cal assistance, is a prerequisite. The banks were able to the costs of dealing with such diseases, and that the bet- accurately assess each proposal to a large extent due to ter practices adopted following the increased access to the high quality business plans that were prepared. In A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 69 addition, the competitive selection of cooperatives to par- To date, the coffee cooperatives participating in COMRU- ticipate in the COMRURAL program helped ensure that RAL have all repaid their loans in a timely manner. This the proposals presented to banks were the most credible is impressive bearing in mind the challenges that they and financially sound and therefore ultimately were also are facing in dealing with the outbreak of rust. Further attractive to bank loan officers. analysis over time will confirm whether this repayment record is maintained. If it is, it will suggest that this com- Public sector funds as grants can be effective in crowding in prehensive approach to business planning, public sector longer term private sector financing for coffee sector enter- grants, and private sector loans offers a promising means prises. The grant element assists cooperatives in undertaking of increasing investment by coffee cooperatives on behalf programs that would be much more challenging should they of their membership. required full private sector financing. This enables coopera- tives to provide essential support services including exten- CASE STUDY 13: DE-RISKING sion, research, and technical assistance to its membership while borrowing from banks primarily to fund infrastructure. THE “MISSING MIDDLE”—THE The investment in both support services and infrastructure CASE OF ROOT CAPITAL, enabled the development of stronger and more sustainable A SOCIALLY-ORIENTED projects with a much greater chance of success. LENDING INSTITUTION A value chain approach to projects ensures that those OVERVIEW investing in developing production and productivity are This case study considers the experiences of Root Capital, also focused on ensuring access to markets. This enables a nonprofit social investment fund, in its financing of cof- these projects to succeed as marketing channels are secured fee sector cooperatives. Root uses alternative approaches alongside production, and gives lending institutions reas- to provide financing to cooperatives that are unable to surance about the robustness of the business plans. access finance from commercial banks, or cannot access sufficient loans, or loans of sufficient duration and appro- This approach can work for cooperatives that have never priate terms for investment purposes.97 accessed bank financing before as well as those that have. While Capucas had existing banking relationships, ABOUT ROOT CAPITAL COCASJOL had never previously accessed bank financ- Root Capital is a nonprofit social investment fund that ing. This demonstrates that these programs have potential delivers credit, typically ranging from US$50,000 to US$2 for the less established or smaller cooperatives. As long as million, as well as financial training to agricultural busi- a cooperative can show a credible and compelling busi- nesses aggregating smallholder farmers in Latin America ness plan, the banks appear willing to lend, where previ- and Africa. Its ultimate goal is to help improve rural ously they may have been reluctant. A large part of this livelihoods and promote environmentally sustainable agri- is no doubt due to the business advisory services provided cultural practices. Root Capital’s clients include producer to the cooperatives in preparing their business plans, the associations and private businesses that source and/or inclusion of marketing/value chain elements alongside production infrastructure, and to an extent the use of the public sector grants to cover additional project activities 97 Many of Root Capital’s coffee clients are able to access commercial capital; about 66 percent of Root Capital coffee borrowers also had access to commer- that make the projects more sustainable and achievable. cial bank finance in 2013. However, even for businesses with access to commer- cial capital, Root Capital is often supplmentary in terms of the structure and/or The coffee cooperatives involved in COMRURAL have type of loans that they offer. For example, many coffee clients can access short- all invested in extension services to support the invest- term loans from commercial banks, but not long-term loans for investment pur- ment in production, quality, and infrastructure. The link poses. In addition, many clients who, prior to working with Root Capital, may have been unable to access commercial financing are subsequently able to do so, to good agricultural practices goes hand-in-hand with the as they have built a credit history through their Root Capital loans and/or now investment in production equipment, ensuring volumes of have the systems required to successfully apply for a commercial facility through coffee sufficient to maximize returns on the investment. Root Capital’s financial management training. 70 Risk and Finance in the Coffee Sector process agricultural products for both export and domes- FIGURE 5.25. AVERAGE PORTFOLIO tic markets. As of the first quarter of 2014, Root Capital BALANCE IN COFFEE BY had disbursed more than US$659 million in credit to 504 YEAR—2008–13 businesses across 30 countries since its inception in 1999. Central America South America East Africa 20 Most of Root Capital’s borrowers fall into a ”missing mid- Millions (US$) 15 dle” within the financial services sector, in that they are 10 served neither by microfinance institutions (MFIs) nor 5 commercial banks for a combination of reasons, includ- ing common perceptions that the agricultural sector is 0 2008 2009 2010 2011 2012 2013 inherently high-risk, low-return and the basic challenge Source: Root Capital. of reaching remote rural areas. Financial institutions that do lend to agricultural businesses in rural areas generally Root Capital’s entry into the coffee sector was in part have rigid hard collateral requirements that exclude all facilitated by financing the supply chains of Starbucks, but the most formal and best-capitalized businesses. Keurig Green Mountain, Equal Exchange, and other leading coffee roasters. This approach enabled Root to To reach businesses in this missing middle while appropri- significantly expand its outreach in a timely and effective ately mitigating risk, Root Capital uses an innovative value manner. The advantages of working with businesses with chain approach that includes the following key components: pre-established relationships with leading coffee buyers » Evaluation of collateral based on businesses’ future include: sales (purchase agreements) rather than their existing » Acceleration of client identification, as the buyer assets. Typically the borrower is eligible for a loan of can refer the cooperative to Root Capital, rather up to 60 percent of the value of the signed agree- than the latter having to seek out the cooperative; ments. The purchase agreement, in effect, becomes » Simplified due diligence, as the buyer can act as a the collateral—a discrete, future revenue stream reference; and pledged by the borrower to repay Root Capital’s loan. » A credible buyer is already in place: The producers » “Staggered” lending, in which Root Capital offers are already in established relationships with pre- progressively larger and more complex loan prod- approved buyers, thereby enabling purchase agree- ucts to long-time clients as they build their credit ments to be taken as a form of collateral. history and asset base. This enables Root Capital to “grow with the borrower” while managing risk. This is a mutually beneficial arrangement as the buyer is able to facilitate seasonal finance to its cooperative suppliers, which improves the performance of the coop- ROOT CAPITAL AND LENDING TO THE COFFEE SECTOR erative and assists in ensuring delivery of contracted Root Capital made its first loan in 2000 to a coffee coop- coffee. erative in Guatemala. The specialty (that is, premium qual- ity and certified) coffee sector continues to account for the LOAN MATURITY bulk of Root Capital’s lending, although the lender has since During 2013, 71 percent of disbursements consisted of diversified into other agricultural industries, primarily cocoa, short-term trade credit loans (Root Capital 2013)98 with cashew, and quinoa, as well as non-agricultural industries, terms of up to a year, generally based around a single har- such as handcrafts and wild fisheries. As of the end of March vest or production cycle. This product addresses the cash 2014, Root Capital had cumulatively disbursed over US$490 constraint coffee businesses experience between the time million to just under 300 coffee businesses, primarily pro- they purchase coffee from producers and receive payment ducer cooperatives, in Latin America and Africa. In 2013, from buyers several months later. Root Capital accepts roughly 65 percent of Root’s lending, representing US$78.1 million in disbursements, was to coffee sector enterprises. 98 Actuals 2013—data provided by Root Capital. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 71 FIGURE 5.26. PORTFOLIO, COFFEE AND To overcome this challenge, Root Capital (and other NON-COFFEE—2002–13 socially-oriented lending institutions) use purchase Coffee: short term agreements as a replacement for fixed asset collateral. 140,000,000 Coffee: long term The premise is that the contract between a coffee buyer 120,000,000 Non-coffee: short term (importer or roaster) and seller (coffee cooperative) acts Non-coffee: long term as a replacement for collateral. Typically the borrower is 100,000,000 eligible for a loan of up to 60 percent of the value of the 80,000,000 signed agreements to secure coffee from its members, pro- US$ 60,000,000 cess it, and deliver it to port. To this end Root Capital has 40,000,000 worked with over 100 coffee buyers, ranging from small specialty traders and roasters to multinationals, to facili- 20,000,000 tate lending. 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Clearly the value of the contract depends on whether the Year contract will be fulfilled by the cooperative, and as such, Source: Root capital. the lender will usually spend a significant amount of time signed purchase agreements as a form of collateral where understanding the strength of the value chain. This anal- a business would normally need to give hard collateral ysis occurs at two levels: such as land titles or liens on infrastructure. (For businesses » Root Capital evaluates the relationships between working in domestic non-coffee value chains in which they the client and its buyers, taking into consider- are unlikely to have purchase agreements from a major ation how long the parties have worked together, global buyer, Root Capital will take hard collateral if it is whether product rejections have occurred, and available.) the nature of the contract between them and the reputation of the buyer, among other factors. The remaining 29 percent of disbursements were in the The stronger the relationships, the more likely the form of longer-term capital expenditure loans (Root Cap- chance of contract fulfillment and the greater the ital 2013) with maturities of up to five years, that allow value of the security that the purchase agreement enterprises to invest in value-added services or equipment provides. that can lower production costs and raise product quality. » Root Capital also evaluates the strength of the rela- tionship between the cooperative and its suppliers. Figure 5.26 shows the growth of Root Capital’s lending in A strong relationship between an enterprise and its coffee between 2002–13, by loan duration. producer suppliers indicates that value is being de- livered by the enterprise. All else being equal, this COMPONENTS OF ROOT CAPITAL’S will reduce the risk both of producer side-selling VALUE CHAIN APPROACH: THE USE and enterprise default on delivery of contracts and OF PURCHASE AGREEMENTS AS loans. Integrity and transparency of management, COLLATERAL while difficult to measure, are also important to Root Capital delivers credit through a form of value gauge the balance between the management’s ca- chain finance to manage risk. Lending to smaller rural pacity and license to operate as well as producer cooperatives presents a number of challenges for financial oversight and buy-in. institutions, both banks and non-banks. For example, cof- fee cooperatives generally have limited collateral, weak and/ Repayment flows through a triangulation agree- or inexperienced management teams, and organizational ment. An interesting element of the lending methodology structures that at times can prevent effective managerial con- utilized for export-oriented commodities (such as coffee) is trol and decision making. Collateral in particular is generally the use of the tripartite lending structure. This structure is an important prerequisite for commercial financing. highly effective in reducing the risk of nonrepayment as it 72 Risk and Finance in the Coffee Sector FIGURE 5.27. ROOT CAPITAL’S VALUE coffee cooperative), significantly reducing the risk of CHAIN FINANCE MODEL funds being diverted and the loan not being repaid. 1. Order goods The tripartite arrangement ensures that, as such as long as Small & Growing Buyer the commodity (in this case the coffee) is delivered to the businesses 3. Ship goods buyer and meets the standards defined in the contract, the lender (Root Capital) will receive sufficient funds to satisfy 2. Make loan with repayment of the loan. purchase order as collateral 4. Pay for goods 5. Remit payment, The process of building a relationship with clients, net of loan and interest critical to the alternative lending approach of Root Capital, also allows the loan officer to assess the technical assistance needs of the enterprise and Root Capital identify opportunities to build enterprise capacity. Areas of weaknesses identified during the due diligence pro- Source: Devaney, PL (2011), Global Agricultural Value Chains: Sustain- cess can be addressed through Root Capital’s Financial Advi- able Growth as a Means for Sustainable Development, Community De- sory Services (FAS)99 program or in certain cases, through velopment Investment Review–Federal Reserve Bank of San Francisco. Root Capital coordinated third-party agronomic assistance. In 2013, the FAS program provided financial management ties the lending approach into the flow of the coffee, and training to 296 enterprises (Root Capital 2013). Common ultimately adds to the strength of the relationship between training topics, delivered through a combination of work- buyer, producer, and lender. This model has been used for shops and one-on-one engagements, included accounting, a number of years by many of the socially-oriented lend- financial planning, financial risk management, financial ing institutions and has been shown to be effective in rais- statement analysis, and loan application preparation and ing the level of repayment over and above a direct loan to credit management. a cooperative without such a structure. Under this agreement, Root Capital is paid directly by GROWING WITH THE CLIENT: the buyer when the product is shipped; the principal and “STAGGERED” LENDING interest recovered and the remainder remitted to the The value chain approach leveraging purchase con- client. The process is formalized with an triangulation tracts utilized by Root Capital is a means of overcoming agreement signed by the buyer, supplier, and Root Capi- the challenges that financial institutions (both banks and tal, which lays out the responsibilities and obligations of non-banks) encounter when lending to smaller rural coop- each party and the repayment mechanism. The triangula- eratives. The use of purchase agreements alone, however, tion arrangement is detailed in figure 5.27. cannot fully overcome collateral issues facing this sector. Cooperatives often require financing above seasonal coffee The critical elements of success with such a tripartite trade requirements. Cooperatives wishing to expand their arrangement are that: range of services for their membership will require funds » The loan total should never exceed the total value for investment in storage, transportation and logistics, of the physical coffee contract. For contracts that are processing, marketing, and quality. In most situations the price-to-be-fixed, the lender may choose to lend only cooperative will be unable to retain sufficient earnings from a minimum sales value of the contract to ensure that each coffee season to finance these investments themselves. the loan never exceeds the total contract value; In these cases, the lender and the cooperative will need to » Loan maturity is directly related to the delivery of find alternative mechanisms for providing financing. the commodity (the coffee); » Payment for the coffee on receipt by the buyer is made 99 More information on the Financial Advisory Services Program can be found to the lender, rather than directly to the borrower (the on the Root Capital Website: http://www.rootcapital.org/our-approach. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 73 “Staggered” lending describes the approach followed by BOX 5.3. MUSASA (RWANDA): ENABLING Root Capital to deepen its relationship with its borrow- INVESTMENT IN INFRASTRUCTURE ers, while appropriately managing risk. This approach AND EQUIPMENT enables Root Capital to provide more complicated forms of finance over time, above and beyond seasonal finance In 2005, Root Capital extended an initial loan of against purchase agreements. It relies on improving the US$90,000 to the Rwandan Musasa cooperative. In the aftermath of the 1994 genocide, devastated com- mutual relationship and understanding between lender munities in Rwanda’s coffee-growing regions struggled to and cooperative. In essence, as Root Capital works over rebuild. Formed in 2004 by 1,702 growers (350 of them several seasons with a cooperative, its management, and women), Musasa lacked access to capital that would allow its membership, it is able to better understand the business the cooperative to collect all of its existing producers’ cof- and its strengths and weaknesses. Root Capital therefore fee, let alone expand membership. Despite the obvious risks has much greater insight into the realism of the strategy the of lending in a post-conflict region, the agricultural lender cooperative is operating against and is able to identify how identified several strengths that indicated a creditworthy client, including: (and if) they may increase their financing of the enterprise. 1. A committed management team governed by a demo- In this approach, Root Capital uses a series of “gateposts” cratic, transparent general assembly of cooperative allowing a cooperative to progressively qualify for more members invested in the enterprise’s success 2. Reliable product off-take in the form of reputable buyers complex and riskier loans. To illustrate: including international traders Volcafe Specialty a) When first working with a coffee business, Root Coffee and InterAmerican Coffee, whose client list Capital generally starts with a lower risk, simpler included Starbucks and Keurig Green Mountain loan product, such as a short-term trade credit 3. A strong supporting ecosystem of technical assistance providers, loan that involves using a signed purchase agree- certifying bodies, and government agencies to offer support ments with the enterprise and its international in areas such as governance and operations buyers as the main security in lieu of traditional By scheduling multiple disbursements (with an collateral (as described above). initial distribution of US$20,000), Root Capital b) As the enterprise grows stronger in terms of key managed its initial risk. The lender was able to fully financial indicators such as export volumes, net monitor inventory build-up, price risk management, and profit, equity base, and credit history, Root Capi- other indicators of financial health over the course of the loan. tal can extend more complex loans, such as pre- season finance for input distribution to producers. Root Capital scaled and expanded its loan offer- The borrowing base for these loans may be letters ings to Musasa since 2005 by leveraging financial of intent, generally considered less secure than training and the enterprise’s credit history. Since 2005, Root Capital has lent more than US$2.6 million to purchase agreements. Musasa. In addition to progressively larger trade credit c) Finally, as the business builds its credit history and facilities, the improved capacity of the cooperative (aided asset base, Root Capital may provide long-term in part by a 2012 Financial Advisory Services workshop) capital expenditure loans based on the proven has allowed Root Capital to extend three long-term loans client-Root Capital relationship. In the case of for US$25,000, US$30,000, and US$87,000 in 2007, coffee, this could include loans for equipment and 2012, and 2013, respectively. The first two loans were used to purchase trucks to improve logistical efficiency, while the infrastructure such as wet mills, warehouse and third was used to purchase a coffee dry mill that will deliver office space, organic composting facilities, and for efficiency and time-savings. While the first capital expendi- inputs for the replanting (renovation) of aging or ture loan was secured with the asset it financed (the truck) diseased coffee farms (a particularly risky endeavor, in addition to the coffee contracts, the subsequent capital but also one with high impact potential).100 expenditure loans have covered all existing physical assets. In essence, Root Capital has helped Musasa build up an asset base against which the lender can make additional Root Capital currently undertakes work in this area under the Coffee Farmer 100 loans for continued investment and enterprise growth. Resilience Initiative. 74 Risk and Finance in the Coffee Sector BOX 5.4. COOMPROCOM (NICARAGUA): BOX 5.5. UNICAFEC (PERU): LONG-TERM SUPPORTING COOPERATIVE LOANS FOR COFFEE RENOVATION MICROLOAN PROGRAMS In 2013, Root Capital approved a five-year, Since January 2010, Root Capital has provided US$300,000 coffee farm renovation loan for Aso- US$1.98 million in trade credit financing in order to ciación Unión de Cafetaleros Ecológicos (UNI- facilitate the coffee cooperative’s continued growth CAFEC). The association had been a Root Capital client and service delivery to its membership. Cooperativa since 2006, when it accessed non-buyer financing for the first Multisectorial Productores de Café Orgánico de Matagalpa time in the form of a US$100,000 short-term trade credit loan (COOMPROCOM) is a primary-level Nicaraguan coffee to finance its growth. Since 2006, the banking relationship cooperative formed in 2002. Given its relatively small size, had steadily strengthened through transparent communica- remote location and lack of traditional collateral, such as fixed tion and consistent repayment, and by 2010, Root Capital felt assets or titled land, COOMPROCOM has lacked access comfortable extending two alternative loan products to UNI- to commercial bank financing. From its founding in 2002 CAFEC: a US$100,000 pre-harvest credit to capitalize the through 2010, COOMPROCOM twice received financing association’s internal credit fund for on-lending to producer from its buyer so that it could pay its members at the time members, and a US$280,000 capital expenditure loan for the they delivered their coffee. That financing dried up in 2009, construction of cooperative facilities. Meanwhile, total expo- however, and COOMPROCOM turned to Root Capital. sure to UNICAFEC hovered near US$2 million with the asso- ciation’s $1.8M in short-term trade credit received in 2013. After COOMPROCOM repaid its first trade credit loan, Root Capital deepened its engagement by Despite the significant exposure, Root Capital felt extending a pre-harvest credit facility to support comfortable making a five-year renovation loan the cooperative’s microloan program. By providing for several reasons: US$100,000 in pre-harvest credit to the cooperative in 2011 » Acceptable administration of the cooperative’s microloan fund. (subsequently raised to US$150,000 in 2012), Root Capital While UNICAFEC must improve certain compo- enabled COOMPROCOM to forward small sums on to its nents of its internal credit fund management, its membership for household expenses and farm-level invest- overall governance, strategic planning, and processes ments. While a loan of this type involves more exposure to and information systems are adequate to manage a agricultural risk than a simple trade credit loan, it can have loan. Moreover, as part of the coffee farm renovation a significant impact on a smallholder’s well-being. These loan, UNICAFEC has committed to continuing to small advances of money help farmers smooth their other- work with Root Capital’s Financial Advisory Services wise uneven annual income and invest in their farms before team to improve areas of weakness. the harvest begins. Microloans are especially important for » Strong agronomic capacity. Because the loan will be used COOMPROCOM’s most economically vulnerable mem- to rehabilitate and renovate cooperative members’ bers, who experience food insecurity and other economic coffee plantations, it is important that UNICAFEC challenges during the “meses flacos”, or lean months, when have an agronomic team capable of supporting they earn no income but must still pay their daily expenses.a members’ replanting efforts. In addition to an expe- In order to further reduce the risk associated with rienced agronomic staff, Root Capital is partnering this form of lending, Root Capital coupled financ- with a third-party agronomic technical assistance ing with the provision of financial advisory ser- provider to assist, monitor, and report on progress. vices. COOMPROCOM currently participates in Root » Adequate fixed collateral. Over the last several years, and in Link, a targeted Root Capital financial training program part due to loans made by Root Capital to UNICAFEC, that helps strengthen cooperatives’ microloan programs. the cooperative has invested in and accumulated physi- While such training does not guarantee repayment, it cal assets against which Root Capital can now secure strengthens the cooperative’s loan management system and this multiyear loan. In the case of the present loan, therefore reduces Root Capital’s risk. Root Capital will take first position on the cooperative’s land and offices worth a total of US$519,000. a 2013 impact assessment conducted by Root Capital. challenge is to find a means for working with the bor- As highlighted in the above borrower examples, there rowers (and their buyers where appropriate) to build a are significant needs at the cooperatives related to pre- relationship that enables such needs to be fulfilled in a sus- harvest, capital expenditure, and renovation and the tainable manner. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 75 The examples of three coffee cooperatives that received » Develop basic market information and quality as- financing from Root Capital demonstrate the evolving surance and certification systems nature of the relationship between a cooperative and » Develop a system of commodity trade finance Root Capital, and how a relationship that commences based on inventory collateralization using WRS with the financing of coffee contracts between the coop- erative and its buyers can evolve into a more complicated The rationale was that with the opening of markets and set of financing arrangements based upon a growing trust the liberalization of trade, instruments such as warehouse between the lender and the cooperative. receipts have become important in the transition to mar- kets, serving to reduce uncertainty and enhance efficiency. CASE STUDY 14: WAREHOUSE For a WRS to work well, government and industry must build a legal and institutional framework to guarantee RECEIPT SYSTEMS IN THE performance and minimize transaction costs. Warehouse COFFEE SECTOR: AFRICAN receipts, also known as inventory credits, can facilitate EXPERIENCES finance for inventory or products held in storage. These OVERVIEW receipts (or warrants), when backed by legal provisions This case study reviews lessons learned from the promotion that guarantee quality, provide a secure system whereby of warehouse receipts in a number of countries as a means stored agricultural commodities can serve as collateral, of facilitating access to finance and income smoothing by be sold, traded, or used for delivery against financial eliminating forced early season selling when prices may be instruments, including futures contracts. In this context, at their lowest. With the exception of Malawi, the use of warehouse receipts are transferable documents of title warehouse receipts has not really gained traction mainly, it that state the ownership of a specific quantity of prod- would seem, because of an inability to match contractual ucts with specific characteristics and stored in a specific and logistical requirements with small farm realities and warehouse. The receipts represent secure collateral and preferences (which, it must be said, is not easy). In Kenya as such should enable farmers, processors, and traders to and Tanzania however, warehouse receipts are allow- mobilize credit. 101 ing cooperatives and other entities (such as commercial Access to this kind of financing mechanism is important estates) to raise finance against coffee stocks awaiting final because a lack of access to credit for a range of productive processing and sale for export. The actual process is not purposes is a severe constraint for many farmers, especially very different from the conventional collateral manage- smallholders. Often this is further exacerbated by forced ment possibilities that were already available. The main early selling of agricultural commodities at peak harvest lesson however is that for purposes of income smoothing times when prices are low, and in the case of coffee, some- or to avoid forced early selling, warehouse receipt systems times when the crop is still on the tree. While WRS most alone are not sufficient unless linked to the ability to hedge likely was designed to address this risk of forced early sell- the price risk or sell the goods forward. Otherwise grow- ing, such systems can also assist toward more orderly and ers remain fully exposed to price risk and, certainly in the transparent marketing as well as improved access to short- case of coffee, price volatility may work against them. term finance. Background. In 2001, the International Coffee Organi- However, given that coffee ages during storage it should be zation (ICO) and the Common Fund for Commodities sold before it starts to lose quality, WRS can only be used (CFC) initiated a joint project to develop warehouse to fund short-term credit needs, and not the longer-term receipt systems (WRSs) in selected African countries that investment that so many growers need but cannot obtain. would: » Promote privately run warehousing systems » Establish warehouse receipt systems For a detailed overview of a typical WRS system see: http://web.worldbank. 101 » Adopt criteria for selecting warehouses and operators org/WBSITE/EXTERNAL/TOPICS/EXTARD/0,,contentMDK:2044094 » Facilitate the promulgation of supportive legislation 6~pagePK:210058~piPK:210062~theSitePK:336682,00.html. 76 Risk and Finance in the Coffee Sector In contrast to maize farmers, many small coffee growers approved warehouses. However, due to challenges in cannot provide the minimum volumes most WRS opera- the different value chains (for example, cashews, paddy, tors insist upon for reasons of efficiency, making the sys- sunflower, and sesame seed) the uptake is variable. In tem more suitable for aggregators such as cooperatives or the case of coffee, funding is generally only advanced farmer associations. Nevertheless, it is generally accepted against coffee that is delivered to the warehouses of a that in agricultural value chains WRS can be an impor- small number of licensed coffee mills for final export tant potential tool for creating liquidity and easing access processing and auctioning, with the lender assured of to credit, as well as smoothing supply and market prices repayment from the auction proceeds. It could be argued and in so doing improve grower incomes. that this is an extension of the decades-old coffee war- rant system, with the difference that cooperatives (and Under the ICO/CFC project, coffee was the pilot crop other producers) can now more easily obtain finance in both Tanzania and Uganda for the WRS system, and to cover the time lag between final processing and auc- the lessons from these countries will be augmented by the tioning, thereby facilitating first or advance payments to experiences gained through other initiatives in Ethiopia farmers. The system therefore mostly if not exclusively and Kenya, as well as in Malawi and Zambia (maize). facilitates the raising of funds, pending final processing and sale of both Arabica and Robusta, through the auc- Country Findings. In the coffee sector of the coun- tions. This has reportedly led to some primary coop- tries under review, the use of WRS is most prevalent at erative societies bypassing local traders and so achieving the pre-export level; either as part of conventional col- higher prices. lateral management as in Uganda or, through licensed warehousemen where there is a guaranteed and trace- Uganda. The WRS and supporting legislation was able channel for both sale and receipt of proceeds (for established in conjunction with the Uganda Commodity example, as provided by the coffee auctions in Kenya Exchange (UCE) for a number of crops, including cof- and Tanzania).102 In Malawi, on the other hand, WRS fee.103 However, in the entirely-liberalized Ugandan coffee for maize (promoted by The Agricultural Commodity value chain the system has had no response, other than Exchange for Africa or ACE) gained traction once a form at the pre-export level where warehouse receipts linked of formalized trading of warehouse receipts became avail- to collateral management were already widely used. able, and this later expanded into forward trading as well. Reasons include: a lack of warehousing capacity; dis- However, the Zambian approach of introducing a WRS tant locations; individual farmers having to transport the for the maize sector—in conjunction with establishing a goods; minimum lot sizes too high; transaction costs; and fully-fledged commodity exchange—gained no traction, not least, competition from middlemen that offer ready as the approach was neither gradual nor as all-inclusive cash on delivery. In Uganda, some 1.78 million widely and as open as was the case with ACE. Yet, as has been dispersed households produce mostly very small quanti- demonstrated in India, usually commodity exchanges are ties of Robusta coffee that are easy to retain and store; the most efficient at developing appropriate warehouse for most, the minimum quantity required to go for the receipt systems (African Development Bank 2013). WRS option is simply out of reach. Using WRS to raise cash pending processing and final sale would be easier Tanzania. Legislation governing WRS is in place and for cooperatives operating wet mills for Arabica because some 28 warehouses have been licensed by the Tanza- farmers are required to deliver fresh cherry and volumes nia Warehouse Receipt Licensing Board (TWLB). WRS are automatically aggregated. financing is currently available for a number of non- perishable crops, including coffee, which are stored in 103 As of end 2013, there were just six UCE-accredited warehouses, but even 102 The auction systems have always relied on transferable WRS, called war- these were under-utilized. Maize presents a striking example of why this is so: rants, which form the basis for both advance payments pending sale to suppliers The minimum accepted quantity is higher than what most individual farmers (estates, cooperatives, commercial growers) and the raising of funds by export- produce; there is the risk of rejection if the moisture content is too high and ers. The coffee trade worldwide largely depends on borrowed capital. advances are for four months only for 60 percent of the value. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 77 Kenya. While the relevant legislation is in place, ware- Exchange for Africa (http://www.aceafrica.org/default. house receipts are not used in the coffee sector other aspx) was incorporated in 2005 as a spot exchange with than at the pre-export level. Instead, once coffee is trans- trading commencing at the end of 2006. Accumulated ferred to licensed millers for export processing and auc- turnover rose to 40,000 MT in 2010 and 100,000 MT tioning, finance is available from different sources, with in 2012, and currently ACE has 85 registered users from each making their own arrangements in terms of security, seven countries. In due course, however, it was soon clear collateral management, and reimbursement from auc- that without a forward selling option farmers could not tion proceeds.104 Kenya also boasts a vibrant system of manage their price risk, and end users such as millers savings and credit cooperatives, offering credit to farmers and others could not cover their forward requirements. in some areas against future sale proceeds due from the Accordingly, trading in warehouse receipts began in 2011, cooperatives to which they deliver fresh cherry, using the and the first forward trade was set in October 2013. The cherry receipts as collateral. This system has traditionally Malawi experience, even in this brief outline, confirms excluded those cooperatives with weak and inadequate warehouse receipt systems alone are not sufficient for pur- financial track records. poses of income smoothing or avoiding forced early sell- ing. In 2013, ACE traded 615 contracts in mainly soya and Ethiopia. The Ethiopian Commodity Exchange (ECX) maize for a total volume of 67,000 MT and a combined is a spot market based on warehouse receipts that repre- value of US$19 million, compared with just 134 contracts sent standardized qualities of coffee and stored in accred- in 2012 for 19,000 MT worth US$4.7 million. Based on ited warehouses controlled by the exchange. ECX was favorable feedback from potential buyers, ACE is now established as a single domestic coffee marketing channel considering the inclusion of smallholder coffee in its ware- by government decree and, excepting some cooperatives house receipt offering. and large farms, is mandated to handle all domestic pre- export coffee transactions. Only clean coffee (green bean) Conclusion. The notion that WRS can help smooth is transacted and, once deposited, a lot must be sold within prices by avoiding forced peak season or early selling a certain number of days. Once sold, the exporter must assumes rising prices, which obviously is not guaranteed take delivery within a set period. In other words, ECX- for any commodity, especially one as volatile as coffee. issued warehouse receipts are a means of transferring Therefore, without some form of price guarantee, such ownership from seller to buyer and are not necessarily as being able to forward sell stored commodities, growers intended to facilitate the storage (and financing) of cof- remain fully exposed to price risk. fee. After purchase, exporters then rely on conventional collateral management arrangements to securitize their An ability to sell forward implies there are buyers willing borrowings. to purchase forward, quality is standardized, terms and conditions are clear, and both warehouse receipts and for- Malawi. The coffee sector is split between some large- ward contracts are enforceable in law. In most instances, scale producers and a smallholder segment in the coun- only a fully-fledged commodity exchange can satisfy try’s north, neither of which use warehouse receipts in the these requirements but, with the exception of Brazil and strictest sense. However, there have been recent develop- despite a number of attempts to establish them, formal ments in the maize sector. The Agricultural Commodity coffee futures contracts have not gained traction in coffee- producing countries. 104 WRS was introduced through a public/private partnership initiative to facili- tate the trade in a liberalized cereals market, particularly maize, using extensive facilities owned by the National Cereals and Produce Board and other stake- A WRS has to be backed by adequate financial services, holders. The intention being to enable cereal producers to raise their immedi- including cash disbursement of advances on delivery. ate cash needs without having to sell, which would mean forfeiting the higher Otherwise many small farmers will not part with their cof- prices that traditionally prevail once the early season’s sales rush to raise funds fee, particularly where they have difficulty accessing local has eased. Sensible as this seems, the fact remains nevertheless that there are no guarantees prices will in fact rise and farmers are exposed to the risk of falling banking services because of their remote location or other prices. constraints. 78 Risk and Finance in the Coffee Sector TABLE 5.5. PERFORMANCE OF COOPETARRAZU AND PRICE VOLATILITY EXPERIENCED DURING SEASONS 2011–14 NYKC NYKC Change Harvest Crop Local Export at Start at End During Season (MT) Sales Sales cts/lb cts/lb Season 2011/12 6,954 2,450 4,504 290 186 -/- 35.8% 2012/13 7,625 3,127 4,498 165 136 -/- 17.5% 2013/14 10,206 2,722 7,484 115 185 + 60.8% Conventional collateral management remains the norm in coffee, with WRS mostly inaccessible for individual CASE STUDY 15: THE small growers who come into play only at the aggregator BENEFITS OF MODERNIZING or commercial grower level. COSTA RICAN COFFEE COOPERATIVE Work in Malawi (through ACE) confirms that a fully-fledged warehouse receipt system should offer a combination of COOPETARRAZU106 certified storage, collateral finance, market access, or trade Overview. This case study reviews the progress made facilitation, forward contracting and small operator inte- by Costa Rica’s Cooperativa de Caficultores y Servicios gration, all backed by performance guarantees and further Múltiples de Tarrazú (COOPETARRAZU) in establish- supported by access to transport and price information. ing a comprehensive price risk management (PRM) pro- gram and the resulting impacts. Collateral management is a simpler option. In coffee today, collateral managers manage or monitor goods for Continuing price volatility affects producers hugely and which bank funding is provided, often in the borrower’s makes longer term planning extremely difficult as dem- premises. Collateral managers usually are independent onstrated by table 5.5, based on the COOPETARRAZU operators who are able to post adequate liability and experience: indemnity insurance, without which a bank would of Price risk management programs are the “new normal” course question the value of their services. Services can without which short-term or seasonal funding will either range from verifying that bank advances are used for the be constrained or, at best, (much) more costly. However, intended purpose (coffee purchases) and the monitoring lenders, particularly commercial banks, need to under- of storage and export processing through to actual export stand the need for flexibility when assessing PRM pro- and delivery of receivables (negotiable shipping docu- grams as part of their due diligence. ments) to the bank. By offering services in multiple loca- tions that commercial banks would otherwise struggle to This case study highlights that, without assistance, smaller reach, collateral managers also facilitate access to credit and less well-endowed organizations will find it difficult along the supply chain, commencing, if required, at the to duplicate the progress made by COOPETARRAZU post-harvest or collection stage. This range of services is and others like it. It also shows that different means both much wider and more flexible than that offered by need to be found to enable such smaller organizations to conventional warehouse receipt systems and are therefore access financial risk management instruments, preferably better suited to the coffee trade.105 through some form of standardized approach, adapted to local circumstances as necessary. Like WRS, collateral management arrangements do not address price risk 105 With thanks to the Board and general management of COOPETARRAZU 106 and price risk management, which are issues for borrower and lender to address. and Fair Trade USA. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 79 Producers also are in need of effective protection against especially as the total of their payments at times came the kind of intra-seasonal (and even intra-day) price vol- to less than the prices offered by outright cash buyers. atility seen in the past three seasons. An effective PRM Unless COOPETARRAZU found ways and means to strategy should to a large extent protect the cooperative match those prices, it was likely that side selling would and also its members from the kind of precipitous price gain ground, the coffee intake would fall, the coopera- decline seen in recent years. Over the longer-term, pro- tive’s competitiveness would be eroded, and eventually ducer revenues will inevitably reflect the prevailing mar- services to members would have to be curtailed. The ket price, and it is this uncertainty that makes the raising only answer was to square up to competitors who enjoyed of both working and investment capital so difficult.107 good access to low-cost finance and had multiple means of managing their exposure to risk. The decision was Background. In the late 1990s, COOPETARRAZU made to set the first payment to growers at the levels experienced declining competitiveness as a result of qual- prevailing in the domestic market at the time. As such, ity problems, insufficient finances, and a lack of market COOPETARRAZU began assuming price risk (that is, it access, all of which combined to make membership less was taking in coffee at a set price without knowing what attractive. The COOPETARRAZU Board re-evaluated the sales price would be) and building a risk management its overall strategy and in 2003/04 brought in experi- program to address it. A further expectation was that, in enced managers, assuming that the additional costs would time, such a program might also facilitate access to more be justified through better results. This proved to be the and less costly finance. case, and in time the new management gained the trust of both Board and members. It should be noted that this The introduction of professional management had decision went against a well-established tradition (found already ensured that COOPETARRAZU had strong in many cooperatives) that managers are selected from internal systems and managers familiar with modern within the membership or have close links with leading business practices and who understood that price risk members. The decision to engage executives who had no management was both essential and complicated. Exter- membership links with the cooperative therefore was not nal advisers were brought in to familiarize both Board an easy one. Currently COOPETARRAZU has some and management with the complexities of the available 2,950 active members, 75 percent of whom have less than PRM mechanisms and to design and implement a three- 4 ha planted to coffee. step PRM strategy, including arranging access to a futures trading account. However, around 2006/07, buying competition gener- ally in the form of collectors and exporter representatives PRM must address risks at three stages: before, during and moved increasingly closer to the farm gate (a develop- after the harvest. Exposure to price risk changes as the sea- ment seen in some other coffee-producing countries). son progresses, and so each stage needs to be assessed and This presented COOPETARRAZU with new chal- analyzed separately. Furthermore, a substantial proportion lenges in that its growers were now being offered outright (usually around 50 percent) of COOPETARRAZU’s vol- cash prices that, in many instances, were significantly ume is handled under Fairtrade conditions, with a in-built higher than the first payment under the cooperative’s floor price of 140 cents/lb free on board (FOB), an impor- traditional pricing model. This latter model comprised tant consideration in the PRM strategy when export prices of a conservative first payment on delivery, followed by are around that floor price. Other issues arising from the periodic additional payments as coffee was liquidated, three stages of PRM strategy include the following: with a final payment at season’s end. Growers began to » Before the harvest, local and global fundamen- question whether the old system was worth maintaining, tals, as well as the local crop estimate, are reviewed, leading to the adoption of a forward-looking risk management scenario. This usually comprises a 107 Sales under Fair Trade conditions benefit from a minimum price (currently US$1.40/lb for Arabica), but there is obviously a limit to the amount of coffee mix of purchasing put options to protect against that can be traded under those conditions. price falls, selling coffee forward (short selling) on 80 Risk and Finance in the Coffee Sector FIGURE 5.28. 2011/2012 SEASON CROP 2011/2012 350 First position ICE C-USD/Qq 300 250 200 150 100 9/1/2011 10/1/2011 11/1/2011 12/1/2011 1/1/2012 2/1/2012 3/1/2012 4/1/2012 Source: Intercontinental Exchange (ICE): www.theice.com. a price to be fixed basis (PTBF108) or at outright » Understanding that introducing PRM is a progres- prices. In the latter case, the choice might be to buy sive learning process, and that it is a management call options to protect against price rises after that tool, not intended for speculation sale (or after a forward PTBF sale has been fixed). » During the harvest, a daily position report details THE EXPERIENCE OF THE the overall position: long, short, stocks, break-even, to- PAST THREE SEASONS tal coffee intake, total sales, finances, costs, and so on. The 2011/12 Season. Out of a total intake of Additional decisions are made as required, taking into 6,954 MT green bean equivalent (GBE), 2,450 MT account both domestic and global price developments. were sold to or through local exporters, 4,504 MT were » After the harvest, the total volume collected and exported directly (mostly using the traditional approach sold is known, meaning decisions have to be made to PRM consisting of selling on PTBF basis and fixing on any unsold volume. If no immediate sales are prices when coffee was received). However, put options anticipated, then put options might be used or, as were taken out for 10 percent or 454 MT equivalent COOPETARRAZU has access to a futures trad- as a first experiment. The total cost was US$50,000 or ing account, a hedge using futures combined with 5 cents/lb. The calamitous fall in prices during the sea- a stop-loss order might be considered.109 son proved the point that, in a falling market, put options provide a floor price and the small pilot was a success. COOPETARRAZU progressively developed and applied More importantly, it provided clear lessons because a well-thought out, multi-faceted strategy that demon- money was lost due to over-paying producers in what strates good market insight and sound decision-making. turned out to be a sharply falling market (with prices fall- The main reasons why this has been achieved can be sum- ing by over one-third during the season), which had to be marized as follows: covered from the cooperative’s reserves.110 » Good internal organizational, including a mature board of directors The 2012/13 Season. The total intake was 7,625 MT » Qualified and trained technical management staff GBE, of which 3,127 MT were traded locally and » A long-term vision; financial instruments work bet- 4,498 MT were exported directly. This time put options ter under a clear long-term strategy as a way of were taken out for 2,721 MT equivalent at a cost of minimizing the natural speculative position of pro- US$500,000, or about 8 cents/lb. ducers, who—by necessity—are always long 110 Protecting one’s cost price by selling outright (or fixing existing PTBF sales) 108 It is important to note here that when selling price to be fixed basis (PTBF), as coffee arrives (often demanded by lenders) can result in having to chase sales, COOPETARRAZU’s Board has instructed that fixing shall occur prior to shipping. particularly once the seasonal coffee intake increases sharply; this is particularly This ensures the act of fixing prices does not become pure speculation in the form the case for large operations as COOPETARRAZU. If buying interest is slack of ‘rolling’ fixes from one futures position to the next, in expectation of higher prices. at such a time, this will result in lower prices. Similarly, trying to sell substantial 109 A stop-loss order is triggered when the relevant futures price reaches a pre- volumes forward ahead of the season on PTBF basis may depress one’s differen- established level but it is worth noting a) that futures trading involves financing tial and once a lower differential for a well-known quality coffee is in the market margin calls and b) that volatility caused by so-called program or flash-trading it is more difficult to increase this later. Forcing sales for reasons of liquidity is can cause price shifts that could make it impossible to execute at the stated price. never good and COOPETARRAZU’s PRM strategy aims to avoid this. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 81 FIGURE 5.29. 2012/2013 SEASON First position CROP 2012/2013 190 180 ICE C-USD/Qq 170 160 150 140 130 120 110 100 9/4/2012 10/4/2012 11/4/2012 12/4/2012 1/4/2013 2/4/2013 3/4/2013 4/4/2013 Source: Intercontinental Exchange (ICE): www.theice.com. FIGURE 5.30. 2013/2014 SEASON First position CROP 2013/2014 220 ICE C-USD/Qq 200 180 160 140 120 100 9/17/2013 10/17/2013 11/17/2013 12/17/2013 1/17/2014 2/17/2014 3/17/2014 Source: Intercontinental Exchange (ICE): www.theice.com. As prices continued to fall, this much larger exercise contracts remain to be fixed. This enables management to proved profitable for COOPETARRAZU, although over- review the PRM strategy on a daily basis and to react as all grower prices of course fell compared with the pre- may be necessary. vious season and the cooperative’s income was lower as well. But, more importantly, the experience helped shape COOPETARRAZU totally avoids speculation and instead the three-pronged approach COOPETARRAZU now aims at obtaining the best possible average sales price over takes in respect of PRM: a season. Members are paid a market-related price on » Before the season, local and global fundamentals are delivery and, depending on COOPETARRAZU’s finan- analyzed to form a view on trends and expectations. cial results, a final payment at the end of the cycle. » Previously-collected data and field forecasts are gathered and projected into a crop estimate. The 2013/14 Season. Total intake rose to 10,206 MT » Already concluded sales commitments (PTBF con- GBE, of which just 2,722 MT sold locally and 7,484 MT tracts) and previous sales patterns are similarly was exported directly. This time puts were taken out for documented. 4,536 MT equivalent, at a cost of 10 cents/lb or a total investment of US$1 million. This positioning reflected a much larger intake and the now established conviction At this point the cooperative will decide whether to await that, in fact, options purchases are in effect investment in the actual harvest before purchasing any put options a form of insurance and as such as are a key aspect of the to secure a floor for the coffee to be purchased or to fix cooperative’s PRM strategy.111 In this instance, however, already concluded PTBF forward contracts, which means and to the surprise of many, the market strengthened. taking a short position against the coffee to be purchased. In the latter case, a further decision will have to be made As a result, the purchased options expired without any on whether or not to purchase any call options to pro- gain but their cost was easily offset by the strong gains tect those fixes against unexpected price rises. During the season itself, a daily position report provides: local and 111 In the previous year (2012/13), COOPETARRAZU conducted an intensive international market information; all stocks by type, their training campaign on the prevention of lead rust or Roya. As a result, members cost, and whether sold or unsold; all sales commitments suffered little loss and in fact, due to favorable, conditions generally harvested a and whether covered by stocks or not; and which PTBF larger crop than in previous years. 82 Risk and Finance in the Coffee Sector made on the unsold physical coffee covered by the puts. By demonstrating that put options can secure a floor price The overall result was highly profitable as COOPETAR- for coffee still to be collected, COOPETARRAZU hoped RAZU was able to benefit from the improved market, to convince the banks they could make advances without having had a floor price in place for their unsold stocks.112 insisting on previously-agreed fixed price contracts.114 This in turn would allow the cooperative to make its sales Even so, the main issue for all involved was to view the decisions based on market realities, rather than liquidity loss on the options not as money lost but as the cost of needs. While the general consensus was positive and more insurance; in this case price insurance. However, the price information has meantime been provided, indications volatility of just these three seasons has made it unequivo- nevertheless suggest a continuing reluctance on the part cally clear to both the Board and individual growers that of commercial banks to move away from what is seen as a having an effective PRM strategy in place is the ‘new nor- proven and safe arrangement. The reaction among social mal’ and that there is no going back. lenders, on the other hand, was more positive in that the use of options is increasingly seen as minimizing risk; a COOPETARRAZU’s experience during these seasons significant factor when executing due diligence and set- reflects the culmination of a decade-long program of ting interest rates . . .115 investment in both personnel and training. Given that at its inception COOPETARRAZU was already an established This confirms once again the importance of ensuring and relatively well-functioning and well-resourced organi- borrowers and lenders both understand the intricacies zation, it also demonstrates that such proficiency takes time of the trade in coffee and how PRM can be applied. to develop. Notably, COOPETARRAZU was fortunate in But most cooperatives and similar organizations do not having the resources to fund its put option program, using take advantage of the kind of resources employed by a combination of own reserves and credit lines. COOPETARRAZU to purchase its puts, meaning that in many instances lenders may also have to consider financ- The Link Between PRM and Access to Finance. ing the cost of options. Depending on circumstances, that Following the successful 2011/12 pilot effort, COOPE- cost can be significant, which could be discouraging or out TARRAZU convened a meeting with a number of of reach for producers of mainstream types of Arabica financial institutions to discuss and explain the potential and Robusta (as these coffees generally sell at much lower benefits of its three-pronged PRM program (forward prices than the high-quality Mild Arabica as produced contracts, hedging, and options) that included securing by COOPETARRAZU). Finally, there are also examples a floor price for unsold stocks using put options.113 The of producers losing interest in PRM, for example when main objective was to rectify an oft-encountered belief prices are rising and they are doing well or, when prices that fixed price contracts are the best, if not the only, are so low that they see the cost of options as representing way to secure advances. Understandable as this may be, yet more loss. However, irrespective of price levels, with- it nevertheless pushes the borrower to make sales deci- out PRM the cost of finance will arguably be higher and sions based on liquidity issues rather than marketing pri- marketing options may be constrained.116 orities and, in fact at times may have detrimental effects. 114 Fixed price contracts is meant here as either an outright sale equal to the 112 Of course, the puts were not all bought at once. As it turned out, the crop price agreed or a PTBF sale for which the price has been fixed. was some 20 percent more than expected, but once the originally estimated 115 In the case of Coopetarrazú it is difficult to judge by how much, or if at tonnage was reached, instead of buying more puts, they reverted to either fixing all, the PRM program reduced interest rates because given its status as a well- contracts or leaving unsold stocks uncovered, believing the market was rising established undertaking with a good track record, the cooperative already and that it was safe to do so. obtains prime rates, being classified as an A-class client. But the PRM program 113 Banco Popular, Banco Nacional de Costa Rica, Banco de Costa Rica, does play a role in their negotiations with lenders and, in some instances, has Responsibility, and Oikocredit (the latter two being social or alternative lend- facilitated discussions around the provision of collateral. ers). Remarkably, the cooperative not only brought along two experts to explain 116 Predicting where the market is heading is an inexact science at the best of both the trade in coffee, the use of futures markets generally, and the step-by- times as demonstrated by the old trade saying that “when prices rise coffee is step process of its PRM program, but it also invited representatives from other never too expensive, and when prices fall it is never cheap enough,” meaning no cooperatives to take part. one knows and PRM remains relevant, always. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 83 Outcome. Domestically, COOPETARRAZU has been ing the use of options, with the aim of protecting able to compete more actively because it has emerged as their estimated break-even point from price falls. a kind of price setter rather than a price follower, given » The strategy enables them to set a competitive first that it can secure a floor price for the coffee it collects. payment to growers, determined by the volume of But, more importantly, like its competitors the coopera- Fairtrade and other pre-season sales (mostly, if not tive is now also able to offer medium and large producers all, PTBF) they have on the books, coupled with (who might otherwise channel some or all of their coffee their assessment of the market, the projected har- through third parties) the possibility to sell coffee forward vest, and the level of unsold stocks. The season’s to it, either at a fixed price or on PTBF basis. When buy- strategy is built upon this information and can in- ing outright or once a PTBF purchase is fixed, the coop- clude the use of options when judged appropriate. erative will cover its price risk in one of three ways: fixing » Board Members and management understand not the price on one of its own PTBF forward sales contracts; only the complexities and the basics of these strat- buying put options; or conventional hedging using its own egies, but also the fact that PRM should exclude futures account.117 speculative activity. » The cooperative’s position is marked to market dai- In terms of cost to the organization, nearly all the cumula- ly and there is total transparency between Board tive expenditure on the futures account for these past three and management. seasons was matched by price changes on the correspond- ing physicals, whereas the puts were judiciously managed Naturally, this case study must not be taken to infer that in terms of realizing their value in years one and two when producers can be fully protected against the kind of intra- prices fell, and still obtaining some residual value in year seasonal (and even intraday) price volatility seen in the three, even though prices rose. All this must necessarily past three seasons. When prices fall precipitously during a be seen in the light of COOPETARRAZU’s financial season, an effective PRM strategy should to a large extent strength and ability to carry this account; such a model is protect the cooperative and, as happened in 2013/14, not for each and every cooperative or farmers’ organiza- also its members. But over the longer term, producer rev- tion. Nevertheless, these kinds of operations do not have to enues will inevitably reflect the prevailing market price, be on this scale and can in theory be replicated with much and it is this uncertainty that makes raising both working smaller volumes. The reality is, however, that few financial and investment capital so difficult.118 institutions would be interested in handling such relatively small transactions. With regards to access to finance it Lessons Learned by COOPETARRAZU: appears that the improvement in the cooperatives manage- » Professional input is essential to support the ment of risk has enabled them to improve their negotiating learning process, that is, an organization wishing position with their bankers. However, it has not directly to implement a PRM program will need to secure resulted in a reduction in the rates of interest that they pay outside support. The objective should be to sup- or an improvement in other lending conditions. port the learning curve and promote knowledge rather than any particular programs or packages. Conclusion. Today, COOPETARRAZU basically con- » Executing a risk management strategy requires ducts the trading side of its coffee business like any other qualified, professional personnel who are able to well-resourced and experienced exporting house, and is manage the program under the overall direction fully competitive. Its strategy was effective because: of the board, meaning that individual board mem- » It progressively developed a PRM program that bers too should be taking on board the necessary combines physical and financial strategies, includ- insights. 117 This is in response to competitors offering the same facility and may in the 118 Noting of course that sales on Fair Trade conditions benefit from a minimum future be extended also to smaller suppliers, even though experience to date price (currently 140 cents/lb for Arabica) but that there is a limit to the amount shows members have been better off receiving the season’s average value. of coffee that can be traded on those conditions. 84 Risk and Finance in the Coffee Sector » Decision-making processes have to be formalized, » Put options might also be preferable at times when must be disciplined, and should involve more than the available differentials on forward PTBF sales a single person. Daily, fully inclusive position re- are too low. ports are a must. » Some bank staff often do not understand how futures » A hedging program requires its own financial re- work. For some, options are easier and more straight- sources; otherwise there is a risk of diversion of forward because there are no issues around potential working capital from the collection of coffee. As margin calls; in effect, options look more like an in- such, this requires parallel finance, which is often surance policy. Having put options in place means difficult to find (COOPETARRAZU at least in a certain volume of coffee has at least a minimum part invested their own capital). Hedging through value, making it potentially easier to raise funding. futures is therefore problematic in that it can result in substantial margin calls that could affect overall liquidity.119 CASE STUDY 16: NSANGI » Risk management is a long-term strategy, meaning COFFEE FARMERS that even if this year’s results are not optimal, the ASSOCIATION, UGANDA program continues over coming years. A short-term focus by a cooperative will result in programs ter- OVERVIEW This case study details the experience of a newly-formed minating early and leave the cooperative exposed. coffee cooperative in Uganda that grew speedily but » The cooperative, management, board, and mem- faced challenges that included high counterparty risk and bers must all understand that not all risks can be member side-selling. The objective is to illustrate how covered by a PRM—basis risk is a good example.120 aggregated farmers can succeed in accessing credit and » Futures should never be used for speculation by expanding their marketing options, but also to highlight these organizations. Wherever possible, the coop- the challenges that might arise if internal management erative should use physical strategies to manage procedures do not keep pace with that expansion. price risk, that is, trade back-to-back. » Understand the basics, primarily that buying cof- Background. The Nsangi Coffee Farmers Association fee outright generates a long position that has to be is located in Wakiso District near Kampala, Uganda, and protected against price falls. was registered in April 2005. Its members produce Natural » Understand the relationship between local prices Robusta. Nsangi was established as a farmers’ association and futures, that is, know what basis risk is and en- through a national body known as the National Union sure constant monitoring. of Coffee Agribusiness and Farm Enterprises (NUCAFE), » Understand it is not always possible to protect a which promotes farmers’ organizations. price for all the harvest, whereas protecting the break-even on unsold stocks (including coffee un- Uganda mostly produces Natural Robusta (although Ara- der process) should be prioritized. bica output is growing strongly). Yields are generally low, » When faced with uncertain supply prospects in and many farmers complain of poor returns from Robusta terms of volume and quality, it may sometimes coffee. Most Robusta is traded for cash, either as dried be preferable to persevere with put options rather cherry at the farm gate, or as variable quality “clean” cof- than trying to sell forward. fee that has been hulled before sale to collectors. 119 Logically, a cooperative will always be long in that it has to buy its members’ Progreso NL, a Netherlands-based foundation, which coffee. Failing forward or back-to-back sales, the temptation would obviously works with smallholder associations and cooperatives, be to short futures, but this is both dangerous and could become a financial identified Nsangi as a potential candidate for assistance albatross if the market moves suddenly and sharply; this as opposed to using because it was a new producer organization in the Natural options, which carry a one-off cost. 120 Basis risk is the risk that domestic prices do not move in tandem with the Robusta smallholder sector where access to funding is often international market. far more difficult than in the Arabica sector. Producers of A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 85 washed or mild Arabica are more often singled out for there were no liens as such over property, stocks, or receiv- such assistance because, usually, they are already aggre- ables, nor was there involvement by any local commercial gated around a central point, such as a washing station or bank in this funding arrangement. The funds received wet mill. At the time of Progreso’s intervention in 2009, were used by Nsangi to finance the collection of cof- Nsangi was unable to raise formal working capital. With fee from its members, as payment for the coffee exports members being equally unable to provide any funding, would not be received until the coffee was loaded. This the Association relied on weekly advances from local trad- funding enabled Nsangi to fulfill larger direct orders to ers and exporters to collect coffee. It sold rough hulled or buyers, including for export, whereas previously they had Fair to Average Quality (FAQ) type coffee to local export- be forced to sell locally every few days to free up cash for ers, using third party hulling plants to do the processing. further purchases. Nsangi became a member of 4C121 in 2010 but to date has not sold any 4C-compliant coffee. It maintains a seed- TRADING STRATEGY Nsangi began trading coffee mostly back-to-back, in which ling nursery, and assists members with drying materials buyers provide a firm price enabling the cooperative to and technical assistance. It also runs a small poultry busi- make market related payments (on delivery of coffee) to its ness. After leasing a small hulling plant, Nsangi was able members. As the business grew into exporting, so pricing to process coffee to exportable quality, resulting in both gradually became differential-based, set against the Lon- higher sales values and a more diversified portfolio of don Robusta Futures Market with Nsangi realizing positive buyers. While initially Nsangi could only export through differentials.123 It is noteworthy, however, that the coop- NUCAFE, in 2011 it obtained its own export license. In erative members did not necessarily understand market February 2014 Nsangi also became Fairtrade certified. behavior and as of today many still do not, meaning that Funding. Progreso commenced its program with Nsangi internal decisions made by the cooperative management by providing technical assistance under its Producer with regards to pricing of coffee, which could be driven by Development Program. This included strengthening insti- activity in the futures market, may at times not have been tutional and management capacity, improving financial fully understood by the members. Progreso began provid- literacy, introducing risk management, as well as pre- and ing training in risk management to address this knowledge post-harvest training for producers in an effort to make gap, stressing also the importance to the cooperative man- Nsangi more “bankable.”122 On the basis of improved agement of the need to stay away from speculative deci- sions. Generally speaking, Nsangi was making progress on prospects and commitments by some buyers to channel different fronts as captured in table 5.6. payments (receivables) via Progreso, the Progreso Cof- fee Fund then provided a first facility of US$55,000 for Subsequent events, however, proved to be fairly 2010/11. Satisfactory settlement of this first facility was dramatic. Firstly, using part of the funds received from followed by approval of a larger facility of US$187,688 the Rabobank Foundation, Nsangi provided outright pre- for 2011/12 as, in general terms, it appeared Nsangi was season cash advances to its members in the expectation this making good progress (although there were questions would result in larger coffee volumes. But this was done around the financial statements for 2011). As the lending without having an effective administrative procedure in amounts grew, along with an appreciation of the associ- place to ensure that these members would actually deliver ated risks, 2012 funding for Nsangi was provided by the the coffee, or would refund the money if they could not Rabobank Foundation with supervision by Progreso. The deliver coffee. A large number, in fact, delivered no cof- funds were transferred directly to Nsangi, relying mainly fee whatsoever, leaving Nsangi with a substantial financial on export contracts with preapproved buyers, meaning 121 4C or Common Code for the Coffee Community is a mainstream base- 123 In this context “differential based” means Nsangi was able to sell at prices standard for sustainable coffee production that relies on verification rather than linked to the prevailing price at the London Robusta futures market plus a dif- certification. ferential for better quality. However, all the contracts were concluded at fixed 122 See www.progreso.nl. or outright prices. 86 Risk and Finance in the Coffee Sector TABLE 5.6. KEY ASPECTS OF COOPERATIVE STATUS QUO AS OF THE END OF 2013 PERFORMANCE 2008–12 As a result of these developments, Nsangi’s 2013 turnover Details 2008 2009 2010 2011 2012 fell to just 57.4 MT valued at US$98,423, whereas the total Membership 700 700 843 950 1200 outstanding amount at year-end stood at US$144,000, Of which 4C 329 505 510 506 506 plus interest. As a result, Nsangi did not obtain any exter- certified nal funding for the 2014 season and it will rely once again Hectares in 1500 2560 2560 2950 3826 on local exporters making short-term advances against production coffee received from members, with Nsangi delivering Clean coffee 60 174 78 215 273.6 ungraded coffee within a few days as before. Neverthe- sold M/T less, and despite all this, Nsangi has been able to obtain Total sales 32.513 79.999 75.950 241.136 290.930 Fairtrade accreditation and is attempting to regularize its revenue 4C verification as well. One exporter has expressed inter- US$ est in continued dealings with the Association, agreeing Of which nil nil 23% 38% 22% to make payment through the Rabobank Foundation or exported to make deductions in terms of the repayment schedule agreed between the lenders and Nsangi. In addition, the membership has agreed that the bulk of future Fairtrade shortfall. In fact, it could even be assumed that the pro- premiums will be retained to further reduce the Associa- vision of preseason cash advances may have encouraged tion’s debt, as will any future income from operating the some farmers not to provide coffee to the cooperative and hulling plant once installed. instead sell to other collectors, thereby avoiding repay- ment of the loans received.124 LESSONS LEARNED Despite having received preseason advances, some 45 per- Secondly, in 2011/12 Nsangi had concluded a first sale cent of members did not honor their delivery obligations, to a buyer in China that had been settled satisfactorily side-selling their coffee instead. This demonstrates how through payment against presentation of documents. difficult it is to establish cohesion in newly formed farmer Based on this experience, Nsangi in the following sea- organizations; and the greater the number of members, son agreed to hand the documents for a subsequent sale the more difficult this becomes. Obviously, it can take “in trust” to the same buyer who then simply did not pay, time for members to absorb new ideas, and not all farm- thereby increasing Nsangi’s financial shortfall by a further ers share the same goals, particularly when it comes to the US$39,850. handling or sharing of finances. While provision of pre- season finance can work effectively if the cooperative has Thirdly, Nsangi transferred its operations to newly-leased an established membership and procedures in place for office/warehousing premises in a new industrial estate ensuring repayment, where this is not the case members and was preparing to install a hulling plant. Previous land should only be paid for coffee on delivery. Nsangi will in owners, however, subsequently claimed they had been the future only advance cash against actual deliveries or unfairly evicted during the establishment of the estate develop a system of “trusted farmers” who will benefit and Nsangi was targeted by people who came to reoccupy from cash before deliveries.125 “their land,” resulting in the theft of substantial quanti- ties of both clean coffee and coffee for processing, as well as other property. As a further consequence, Nsangi was unable to install its newly-acquired hulling equipment for 125 To date, a mapping of farmers has been undertaken, primarily in the zones which it had paid but could not use for the 2013 season. and locales where farmers are perceived to be more trustworthy. The criteria for “trusted farmers” include those farmers who continued to deliver coffee even during challenging periods for the cooperative. In addition, focus to date has 124 Nsangi estimates that in addition to the no-shows, other members only sup- been on fairtrade certified farmers who already are meeting obligations related plied between 40 percent and 45 percent of their actual production. to maintaining their certification. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 87 Handing over shipping documents “in trust,” that is, actually access those third party funds. The question then directly to a buyer without a commercial bank’s interven- is how to link “soft financing” with normal commercial tion, is not advisable for newcomers to the coffee trade, as and financial discipline without reverting to something it suggests a need for trade awareness and training. Coop- like collateral or micro-management. eratives exporting directly need to ensure that they have trained export managers in place and that they follow best None of the preceding obviates the need for cooperative practices. managers to act professionally by avoiding poor or specu- lative financial and trading decisions, and understanding Making advances directly available to borrowers (that is, the intricacies of the coffee trade, including the handling instead of through local commercial banks) can result in of receivables as shipping documents. Nsangi’s experience transactions that are contrary to the best interests of bor- confirms that broader training in different aspects of cof- rower and lender alike. Nsangi’s in-house decisions on the fee trading, not just price risk management, is essential for handling of cash advances and shipping documents might managers of start-ups, particularly where growth is rapid have been different if, for example, a local commercial bank and exporting becomes part of the business portfolio. had monitored the cooperative’s financial transactions. Another reality is that educating the board of directors and the membership at large along similar lines is equally essen- CONCLUSION tial but will take much longer; some may never really grasp Successful farmer aggregation initiatives recognize the what they have signed up to in terms of both potential ben- limitations associated with varying standards of compre- efits and their own obligations. To address these issues, at hension and fidelity among individual group members. least in part, lenders could either exercise more direct super- They also understand that achieving the necessary group vision or impose more stringent conditions but the latter cohesion is a long-term undertaking that relies on indi- option still leaves the question of supervision unanswered. viduals realizing the benefits associated with being part of a particular undertaking. Such advantages are sometimes easier to demonstrate when a farmers’ group is linked to one or two “anchor buyers,” whose intervention provides CASE STUDY 17: advantages that farmers individually cannot realize.126 STRENGTHENING THE FINANCIAL CAPACITY OF Some of Nsangi’s financial problems might not have arisen if its funding had been provided through the inter- SMALLHOLDER BUSINESSES: mediation of a local commercial bank; even if the actual THE PORFIN PROJECT funds emanated from a third party, that bank’s own proce- OVERVIEW dures would most likely still have applied, and as basically This case study reviews the outcomes of a multi-coun- no collateral was available, some supervision might there- try project aimed at strengthening the internal finan- fore have been exercised over the drawdown of the funds cial management of smallholder organizations while and the handling of receivables as shipping documents. simultaneously improving the ability of board mem- But in many instances (and Nsangi was no exception), bers, management, and individual members to analyze local commercial banks are not interested in engaging financial information and progress reports, and sensitiz- with new entities in the “risky” coffee trade, leaving exter- ing lenders to the opportunities to work with small rural nal lenders with little or no alternative but to go direct in producers. The conclusion is that this three-pronged, assisting their clients to become successful and therefore bottom-up approach was largely successful and assisted “bankable.” Alternatively, a commercial bank’s internal toward increasing and diversifying access to finance for a regulatory regime might limit the applicant’s ability to number of the participating organizations. The methods and tools developed formed the basis for a new financial 126 This is probably the main reason why to date so many initiatives have been management training program at Root Capital, the social based on washing stations and wet mills in the mild Arabica sector. investment fund that supported the project. The lesson 88 Risk and Finance in the Coffee Sector is that this type of systematized approach would ide- The project aimed to strengthen the financial manage- ally form part of every program that seeks to develop or ment capacity of the participating organizations at all lev- improve smallholder businesses, provided such programs els, including their financial systems and procedures and extend beyond one or two business cycles for the partici- building the capacity of the management, members, and pating businesses. If not, there is a risk that neither the board to understand and use financial information. It also system nor its lessons will take hold. set out to facilitate contact with lenders, with the overall aim of consolidating and expanding access to credit and Background. Porvenir Financiero (PorFin) or “finan- so broadening market access. Work on connecting lenders cial future” is actually shorthand for the project entitled with potential clients included carrying out research into “Extending Access to Export Markets by Strengthening the the lending sector in each country and providing contact Financial Management of Small Rural Business Organiza- information and advice on their requirements for lend- tions,” which was co-executed by Root Capital and EARTH ing; organizing meetings where lenders could interact University between January 2006 and June 2010. The Inter- with participating smallholder organizations; and directly American Development Bank (IDB) and it’s Multilateral supporting some of these through the application pro- Investment Fund (FOMIN) provided financing.127 Project cess. Training modules were developed on both managing activities were carried out in Costa Rica, El Salvador, Gua- internal credit systems and on applying for a loan.131 In temala, Honduras, Nicaragua, and Mexico. The PorFin addition, a bulletin called NotiPorFin was published and initiative emerged from the recognition that smallholder circulated to the financial institutions in each country, businesses, in particular those in coffee, depend on access to with the aim of giving them updates on the project and affordable credit yet often lack the necessary financial and sensitizing them to the capacity of the producer organiza- business management capacity to be considered “bankable” tions as potential clients. by either social or mainstream lenders.128 It also recognized that internal conflicts generated by inadequate financial In practice, the project focused mainly on preparing systems (for example, inadequate management of internal organizations to meet the requirements of banks for credit operations, credit risk, financial planning, cost con- lending in respect of accounting systems, financial state- trol, cash flow, and distribution of dividends) could threaten ments, planning and the viability and profitability of their the viability and even the survival of smallholder organiza- operations, and only a small proportion of the project tions.129 This in turn increases the potential risks for lenders. resources were spent on facilitating contact with lend- PorFin was a pilot project for Root Capital, which has used ers. However, the central premise of the project was that the experience to draw on the lessons learned, the meth- through addressing the underlying weaknesses in financial odology, information technology approaches, and tools and management, organizations would automatically become human resources in its own financial management training more attractive to lenders and better able to manage their program, Financial Advisory Services.130 external and internal credit operations.132 Scope and Approach. The project aimed to reach 127 This case study is based on an original project overview by Manel Modelo, 49 organizations in the six countries over a period of four the project director, and the final project evaluation was carried out by IDB/ years.133 These organizations were selected on the basis FOMIN in May–June 2010. of a set of criteria, for example, they had to be exporting 128 An assessment carried out with each participating organization in the early stages of the project confirmed that access to sources of credit was one of the key barriers that could prevent their consolidation and growth. 131 These are available, alongside other PorFin training materials, on http:// 129 The final project evaluation indicated that the majority of participating organi- www.claase.org/e-aprendizaje/. zations had previously experienced internal conflicts due to a lack of appropriate 132 External operations refers to the capacity to obtain and manage credit from financial systems and capacity, which had threatened the solidity of their operations. banks and other lenders; internal credit operations are the systems used to man- 130 Root Capital’s Financial Advisory Services is a financial management age lending to the members of the organization. training program for current and prospective clients, covering topics such as 133 Initially, 55 organisations were selected but six did not participate fully or accounting, financial planning, risk management, financial statement analysis, chose to discontinue their participation. Of these initial 55, 13 were from Gua- loan application preparation, and credit management. For more information temala, nine from Mexico, eight from Nicaragua, eight from Honduras, eight see www.rootcapital.org/our-approach. from Costa Rica, and nine from El Salvador. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 89 organizations with at least an intermediate level of organ- the network of regional consultants the project delivered izational development. Information about the project was 2,297 days of technical assistance with 55 percent of the disseminated through regional networks and meetings, participating organizations receiving more than 50 days and organizations could apply by submitting a letter of of technical assistance. interest and relevant organizational information. Half of the organizations selected were smallholder coffee Results. The objectives of the project were to: farmer associations and cooperatives, with the remainder 1. Strengthen capacity and improve financial man- involved in other sectors, including sesame, honey, fruit, agement of participating organizations spices, and handicrafts. The project was delivered in two 2. Strengthen financial literacy of members and phases, starting with Guatemala, Nicaragua, and Mexico board of directors and extending later to the remaining countries. This stag- 3. Sensitize lenders to opportunities to work with gered approach was designed to facilitate effective project small rural producers management in the early stages of the project and the transfer of knowledge and experience from the first phase Strengthening financial capacity, management, to the second; for example, using consultants trained and literacy. The design of a rapid needs assessment through the first phase to deliver workshops in the second. enabled an initial classification of each organization, so that the activities and materials to be used in the capacity The training approach was based on a combination of building could be adapted to their level of development. national workshops and decentralized workshops with This also served as a benchmark to monitor progress over individual organizations, and tailored technical assis- time. The areas included in the assessment were: tance by locally-based consultants. In addition, all mate- i. Credit management rials developed (14 training modules) were systematized ii. Internal credit operations and uploaded to the Moodle platform134 Cla@se.135 The iii. External credit operations aim here was to make the materials and tools developed iv. Business and administrative management for both workshops and providers of technical assistance v. Financial management/accounting available to the participating organizations, and to create vi. Marketing and commercial management “practice groups” of technical staff from each organiza- vii. Technical and productive capacity tion who, following face to face training events, would con- viii. Services to members and social impact tinue to share experiences online and add to the body of learning materials. It is not clear to what degree this was Based on their assessment, organizations were classified implemented in practice, but in the most recent annual into seven bands: AA, A, BB, B, C, D, and E. In 2008, report from Coordinadora Latinoamericana y del Car- 17 organizations were classified as A, which improved ibe de Pequeños Productores de Comercio Justo (CLAC), to 29 by 2010, representing an increase of 71 percent. which now hosts cla@se, it was reported that the site as a There was also an increase of 30 percent in organiza- whole received 3,500 visits in 2013, has 250 active users, tions classified as BB. At the end of the project, 45 of and that 450 materials were downloaded during that year. 49 participant organizations were considered to be more competitive businesses, with greater financial and busi- In total, the project delivered 239 workshops attended by ness management capacity and increased opportunities 5,847 participants, 31 percent of them women. Through to access finance. 134 Moodle is an open-source online learning platform, allowing users to host training materials and courses via the internet. For more information, see www. Figure 5.31 demonstrates the initial position of the par- moodle.org. ticipating cooperatives (in brown); the green line indicates 135 Cla@se is an online platform developed to make the PorFin materials acces- the project goal, and the blue line shows the final situation sible to a wider audience. It is currently housed by CLAC (Coordinadora with regards to the six main sub-components: Latinoamericana y del Caribe de Pequeños Productores de Com- ercio Justo) and offers free access to a range of training materials relevant to i) Accounting system smallholder coffee organisations. See http://www.claase.org/e-aprendizaje/. ii) Financial literacy 90 Risk and Finance in the Coffee Sector FIGURE 5.31. PRE- AND POST-POSITIONS made changes to their business focus, exploring the local OF COOPERATIVES AGAINST rather than the export market having analyzed the profit- ability of their current activities. Others had developed TARGETS IMPACTO PORFIN joint business ventures with organizations they had met Sistem a contable through the training. It was found that by working on automatizado 50 improving their financial management, many organiza- 45 40 tions had improved their basic organizational systems and 35 Cultura Financiera 30 25 Elaboración de EF y razones internal regulations, and had clearer definitions of the 20 15 10 roles for the different organs of governance. 5 0 Sensitizing lenders on opportunities to work with Socialización de EF Interpretación de EF smallholder producers. Activities in this area included the realization of a regional study in Nicaragua, Mexico, Planificación Financiera and Guatemala to assess the availability of rural finance Antes de PorFin Final PorFin Meta después de PorFin in each. Meetings were held with producer organizations Source: Internal documents from the Por Fin program. in all six participating countries to analyze potential strat- egies for accessing finance and with various financial insti- iii) Socialization of financial statements136 tutions to determine the different models of lending on iv) Financial planning offer; this information was shared with all participating v) Interpretation of financial statements organizations. vi) Financial statement analysis A more detailed supply and demand survey was carried out The project evaluation carried out by Fondo Multilateral with the eight participating organizations in Nicaragua, as de Inversiones del Banco Interamericano de Desarrollo well as two international lenders and three local financial (BID/FOMIN) reported that following their involvement institutions.137 A workshop was held in Nicaragua that in the training program, the boards, supervisory boards, brought together these lenders and producer organiza- management, administration, and members of the evalu- tions to build relationships and analyze together the barri- ated organizations had a higher capacity to use the finan- ers to lending as perceived by both lenders and borrowers. cial information generated by their accounting systems to Lenders presented on the deficiencies of the loan appli- guide decision making. These groups also reported feel- cations they had received, and smallholder organizations ing more confident about avoiding the kind of financial on their current situations and the challenges they had misfortunes they had experienced in the past. There was encountered in trying to obtain loans. The key deficien- also a notable improvement in their accounting, internal cies found by lenders were: lack of financial information credit, and basic organizational systems. from some organizations; incomplete information and the time it took to complete this (for example, 3–4 weeks after Interviews carried out during project evaluation revealed the first information is submitted); organizations that were some additional results that were not among the original financially sound but with legal limitations or deficien- project goals; for example, boards of directors that, as cies; and lack of appropriate guarantees. The workshop a result of their training, were better able to hold staff ended by exploring ways to move forward and suggestions to account and had made some replacements where for further actions, including for example that producer staff were not performing well. Some organizations had organizations need to learn to promote their businesses more effectively to the banking sector, and that lenders 136 Socialization refers to the sharing of financial information (for example, profit and loss statements) by board members with the rest of the organisation. This requires a deeper understanding of this information and its significance on 137 The lenders were second-tier institutions Rural Credit Fund (FCR) and behalf of board members and the appropriate communication tools to share it Financiera Nicaraguense de Inversiones (FNI); first-tier commercial bank effectively with other members. BANEX; and alternative international lenders Root Capital and Rabobank. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 91 need to understand how cooperatives and associations financial institutions, including state development banks, are different from other kinds of businesses, and be more NGOs, SOFOMs,139 savings and credit cooperatives, and flexible with regards to types of collateral and other loan microfinance institutions. Organizations involved in the conditions. first phase of the project (those which participated during the full four years) received 81 percent of the loans. In A training module was developed on applying for a loan, addition, between 2005 and 2009, Root Capital increased which was used by project consultants to train and offer its lending to organizations involved in PorFin by 327 per- technical assistance to the producer organizations. This cent; the total number of client organizations did not module explained in some detail what kind of informa- increase, but it was found that lending to existing clients tion lenders require and how they analyze this. It outlines who were part of the project went from an average of the process step by step of applying for a loan and the around US$260,000 to US$850,000 per organization.140 kinds of information that organizations must submit at each stage, including for example: basic organizational Case studies were written in both the first and second phase, information, certification, financial statements, any future detailing how 10 organizations (of which five were coffee contracts with buyers, crop estimates, bills of lading from organizations) had diversified their sources of finance over previous exports, and the presentation of guarantees that the course of the project. It was found that the value of the would be used to secure the requested loan. Additionally, loans obtained ranged from US$10,000 to US$1 million, the training module aimed to help producer organiza- with interest rates of between 0 percent–17 percent and tions understand the mindsets at commercial banks, their repayment periods of 12–84 months. Loans were obtained interests and priorities, and the kinds of questions they for both short- and long-term investment but the major- ask directly or while analyzing information provided as ity went to trade finance, with a smaller amount for crop part of a loan application. The aim was to prepare organ- maintenance and renovation. izations, particularly those with little or no experience of dealing with commercial banks, to understand the loan With regards to the financial capacity of the organiza- application process from the point of view of the lender tions, it was found that the majority of those which were and therefore to make more effective applications.138 able to obtain loans from local commercial banks were classified as A or BB in terms of their financial manage- Over the course of the project, direct contact was made ment and accountancy practices, indicating that these with 119 financial entities, including local private banks, banks had the most demanding requirements. An exam- multilateral financial institutions, international lenders, ple which supports this comes from Nicaragua, where it and microfinance institutions. In the final year, six organ- was found that commercial banks and the Social Enter- izations with an interest in diversifying their sources of prise Program implemented by BID/FOMIN had the credit were selected for targeted support; 13 credit appli- most rigorous process for analyzing credit applications, cations were accompanied by project consultants, of including a review of governance, human resources, con- which four were successful. sistency in financial statements, management of internal credit operations, evolution of markets, and legal aspects. Overall, during the duration of the project, 54 percent of participants (26 of 49) reported they had improved and diversified their access to finance. Eighty-nine new loans were approved, of which 58 (65 percent) were to coffee organizations. Of these, 45 percent were from the 139 Sociedad Financiera de Objetivo Múltiple, A (SOFOM) is a financial entity alternative lenders and 11 percent from local commercial which may be regulated or unregulated and exists primarily to facilitate lend- ing; clients can invest their own money in the fund and borrow against their banks. The remaining 44 percent were from a range of deposits. 140 The project evaluation suggests that it is not possible to draw a direct causal link between the participation of the organizations in the PorFin project and the See the module on Solicitando un Credito under Capacitacion Financiera at 138 increase in the amounts lent by Root Capital, but it does note that a significant www.claase.org. (Currently only available in Spanish.) increase occurred during the project duration. 92 Risk and Finance in the Coffee Sector CONCLUSIONS or outright price contracts as a basis for a loan when this Preparing smallholder organizations to meet lenders’ can actually pose a risk for producer organizations should requirements, in particular those of mainstream lenders, prices subsequently rise.141 is an effective way to strengthen their financial operations; the results of strengthening their capacity in this area In order to foster relationships between smallholder include improving the overall stability and viability of the groups and conventional financial institutions, there is a business. The increase in access to finance experienced by need for continued investment in mutual learning. Those the participating organizations during the course of the organizations that need or wish to engage with the con- project indicates that the work carried out to strengthen ventional banking sector have to invest in strengthening their financial systems was successful in increasing and and professionalizing their own systems and improve their diversifying their access to credit. understanding in detail of the banks’ requirements. At the same time, apart from the necessity for these potential For some organizations, social or alternative lenders can borrowers to demonstrate their bankability, there is a need act as an entry point, but as volumes grow it would be for ongoing sensitization of lenders on the functioning of of value to their businesses to diversify their sources of the coffee market, available risk management options, and finance. However, the level of interest among producer the opportunities that lending to the rural sector can offer. associations in conventional banking services varies; it was found that producer organizations with existing relation- LESSONS LEARNED IN REPLICATING ships with alternative lenders are often less interested in THE PORFIN APPROACH pursuing opportunities to work with local banks. This is The principal conclusion from the final project evaluation because they are familiar with the loan application proce- by BID/FOMIN was that the success of the project lay in dures of social lenders and they value the relationship they piloting an experimental approach to strengthening the have established and the approach of these institutions. financial capacity of smallholder organizations. There- This perception of easier accessibility is not restricted to fore, the evaluation was concerned with and interested in lending requirements: It was found that, in general, alter- the effectiveness of the approach as tested with the par- native lenders have developed approaches that are flexible ticipating organizations. and responsive to the context, taking into account infor- mation from different actors in the supply chain, such as The evaluation concluded that the bottom-up approach to support organizations and buyers. They have developed a strengthening the financial capacity of smallholder organi- good knowledge of the clients, including their social and zations had been highly effective. The project addressed environmental missions, and they proactively seek to meet issues considered by participating organizations to be of the needs of a rural sector that historically has not been central importance, such as financial analysis, accounting, served by local financial institutions. internal credit, financial culture, and so on. At the same time, the evaluation noted that few training initiatives Contact with the conventional or mainstream banking address these areas of capacity directly. A recommendation sector during the project indicated a trust or understand- made by the evaluation was therefore for other organiza- ing gap that needs to be bridged. On the one hand, poten- tions working with smallholder groups to draw on this expe- tial client organizations need to strengthen their capacity rience and use the materials that have been systematized.142 and procedures to meet the banks’ requirements. On the The evaluation also highlighted the following points: other hand, local banks are naturally risk averse and some- » It is important to carry out a diagnostic visit to all times base their perception of associations or smallholder organizations interested in taking part as part of groups on outdated information. Their processes can be the selection process. This has several purposes: to slower and more bureaucratic than those of the social lenders and they may offer less attractive terms, such as 141 For more on this see Case Study 5: “Minimizing Price Risk through Variable higher interest rates and shorter loan periods, or less feasi- Sales Using Call Options.” ble conditionalities; for example, some banks request fixed 142 http://www.claase.org/e-aprendizaje/. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 93 take a snapshot of each organization’s current state Finally, it is important to note that the cost of deliv- in order to understand their needs; to be able to ery of this program was approximately US$10,000 to group and classify organizations and design train- US$15,000 per group per year. And although direct tech- ing strategies for each; to monitor the development nical assistance was most valued by the producer organi- of each group and the impact of the training meth- zations as a training approach (due to the possibility of ods used; and to correlate each group or category developing trust and working in detail on real systems and (for example, A, BB) with particular hypotheses information), and most wanted the project to continue, few and results, such as access to or diversification of considered it feasible to invest themselves in contracting sources of credit. the local consultants from own resources (although some » It is important to involve managers from the start, organizations covered part of the costs for this during the that is, do not assume their level of knowledge project). This is partly a question of limited availability of without testing it. This is also to ensure that any resources and the prioritizing of other needs and also of recommended changes which emerge from the historical tendency; technical assistance is usually seen as training have the buy-in and support of the man- an externally-funded opportunity provided by NGOs and agers who are responsible for the day-to-day run- other partners, rather than a service that producer organi- ning of the business zations are able to contract for themselves. » Adapt the training events to the needs and level of participants. The project defined two main groups CASE STUDY 18: FACILITATING of participants—members of the organization or board of directors and technical and other staff LENDING TO SMALLHOLDER members—and tailored the materials, training lo- PRODUCER GROUPS—THE cations, and length of workshops to each TWIN APPROACH » Replicate the monitoring and administrative sys- OVERVIEW tem developed by PorFin. This case study demonstrates how value chain partner- » Contract local trainers for specific projects rather ships can assist smallholder organizations to move up the than for the project duration, which in the case of value chain by becoming viable exporters and, in so doing, PorFin led to a results-oriented approach. add value through more stable selling opportunities and higher prices. In the value chain partnership approach, The strong emphasis on quality of delivery in the train- anchor buyers and lenders come together with producer ing design, execution, evaluation and systematization of organizations and facilitate access to funding but, in this the learning processes and materials was also a key factor example, as yet mostly from ethical or social lenders.143 identified by the evaluation as contributing to the project’s The attitude of commercial or mainstream banks to such success. arrangements, however, remains quite variable. The con- clusion is that whilst value chain partnerships require sub- Regarding the length of the project, all organizations stantial time and effort to gain traction, they can and do interviewed in the evaluation expressed the view that they become sustainable in terms of continuity and benefits for would have liked the project to have continued beyond participating farmers. The lesson on the one hand is that its end date. Analysis indicated that changes were more longer-term relationships with lenders and buyers under- embedded in the organizations that had participated since pin the development of smallholder producer organiza- the start. Among those included in the second phase, some tions, and on the other that building financial management changes were planned but it was less certain whether capacity should also include assisting lenders, including these would finally be implemented. The conclusion was that the project had underestimated the time needed for organizations to embed some of the new systems; some 143 Anchor buyers and lenders are those organizations that engage with a pro- only had one or two business cycles to formalize these dur- ducer association or cooperative at an early stage and through their commit- ment, demonstrate the viability of the business and the market opportunities ing the project duration. that exist for the organization. 94 Risk and Finance in the Coffee Sector FIGURE 5.32. TWIN TRADING VOLUMES Most of the producer groups that Twin works with supply 1991–13 (METRIC TONS) washed Arabica but a number produce natural Robusta. 6,000 Total Robusta Arabica While Twin Trading does not buy Fairtrade-certified cof- fee only, it is its core business and the producer organi- 5,000 zations Twin links with through its Producer Partnership 4,000 Programme are either Fairtrade certified or in the process of gaining Fairtrade certification. 3,000 2,000 Approach to Risk and Finance. Twin’s approach to working with smallholder organizations on risk manage- 1,000 ment and access to finance has several key components: – » Developing market access for smallholder groups; 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 in some cases, being the first buyer to engage with Source: Twin Trading. a smallholder group and facilitate their access to commercial or mainstream lenders, with developing their international markets own in-house risk assessment and monitoring tools. » Working in partnership with ethical or social lend- ers to facilitate trade finance and, in a few cases, Background. Twin is a U.K.-based charity working medium- to long-term loans145 with more than 50 smallholder farmer organizations in » Delivering training and advice to smallholder orga- 18 countries, representing approximately 400,000 coffee, nizations on financial and price risk management. cocoa, and edible nuts farmers. Twin’s mission is to cre- » Working with lenders to strengthen their under- ate transformational change for smallholder farmers by standing of the coffee business and price risk and unlocking value for farmers in the supply chain. It does to improve the quality of information they receive this through supporting farmer organizations to become from their smallholder clients sustainable businesses through its Producer Partnership Programme144 and by developing market access through Facilitating Lending. Twin’s interest in facilitating direct trading, marketing, and business advocacy. lending has been driven by both the need to secure cof- fee volumes through Twin Trading and the wider aim of Twin’s trading arm, Twin Trading, began importing cof- strengthening producer organizations’ access to markets fee in 1987, and Twin co-founded the brand Cafédirect on sustainable terms. in 1991. Today, Twin Trading markets Fairtrade and sustainable-certified coffee to buyers in the United King- As is clearly illustrated in the body of this report, producer dom, Japan, various European markets, and the United organizations have a range of finance needs that can be States, pursuing where possible a strategy of long-term broadly understood as: relationships and strategic partnerships with its buyers. » Short-term needs for export finance (usually linked Recent examples include collaboration with Finlays, a to contracts)—typically for 1–2 months leading coffee roaster, and Sainsbury’s, the second largest » Working capital needs for the season (not usually U.K. retailer, to develop and launch three single origin cof- linked to contracts)—for example, for 6 months fees produced by smallholder organizations in the Demo- » Medium- to long-term needs for investment loans cratic Republic of Congo (Sopacdi), Malawi (Mzuzu), and (typically 3–5 years) to fund infrastructure, expansion/ Rwanda (Kopakama). diversification or renovation of coffee plantations 144 In 1997, Twin formally constituted its Producer Partnership Programme In Twin’s experience, the most challenging stage for a pro- after having offered ad-hoc support to smallholder producer organizations for a ducer organization to access trade finance is when they number of years. This program supports coffee cooperatives and associations in six areas: strengthening financial management and business basics; governance; quality and adding value; climate and environmental management; women’s Ethical or social lenders: lenders whose mission includes enhancing the eco- 145 empowerment; and market access. Visit www.twin.org.uk for more information. nomic and social development and sustainability of their smallholder clients. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 95 are newly-established in the market but, fortunately, in the organization capacity, facilitating market linkages, lending last 10 years there has been significant growth in the num- directly, and developing relationships with ethical lenders. ber of social lenders who are willing to engage with small- holder groups. However, these usually require purchase The approach to facilitating lending mirrors that of Twin’s contracts or at least letters of intent to buy from regu- Producer Partnership Programme, which is to support lar customers such as importers or roasters, which poses the incremental progress of the producer organization a challenge for those who are just beginning to develop while building relationships and trust between the dif- commercial relationships, in particular at the start of the ferent actors. Where necessary, Twin’s knowledge of the season. Where harvest periods are relatively short, pro- producer organization, including its management capacity ducer organizations are under pressure at the start of and financial strength, has acted as a kind of informal guar- the harvest to gather coffee so that samples can be sent antee or collateral during the initial period when the lender to buyers to agree contracts. But without actual contracts can get to know the client and test their performance. in place, it is very difficult to access the working capital necessary to collect that coffee, meaning the opportunity The usual pattern of development has been to begin by to collect a large portion of the actually available coffee supporting producer organizations to access trade finance may be lost because finance may not become available against contracts with Twin Trading or other buyers; as until the season is well underway and contracts have been trust grows between producer organizations, buyers, and concluded. lenders, it becomes easier for producer organizations to access working capital for the season and longer-term Although the context varies from one country or region to loans for investment in the business. In general, Twin does another, there are common barriers faced by smallholder not work to establish new producer organizations from organizations in accessing finance, including: scratch and works instead with groups that are in the early » Inadequate financial systems and internal capacity stages of their development or those with more experi- » Lack of knowledge or awareness of who to ap- ence that can still benefit from strategic support and a proach to access finance partnership approach.148 » Unwillingness of mainstream banks to lend to smallholder agricultural groups, due to perceived FACILITATING TRADE FINANCE high risk and lack of understanding or knowledge Early experiences. In the mid-1990s, Twin explored ways of coffee sector to offer prefinance to smallholder groups by creating a » High interest rates offered by local commercial revolving fund, managed by Twin but funded externally banks146 (initially by a private investor through Solidaridad in Hol- » Lack of guarantees (assets), in particular for longer land). On presentation of a contract (either with a third term financing party buyer or with Twin Trading) producer organizations » Lack of regular buyers could borrow up to 70 percent of the value with a limit of » Inadequate price risk management procedures147 Response. To meet producers’ export finance needs, 148 The value of investment in Twin’s Producer Partnership Programme has varied over time; in direct relation to Twin Trading’s own purchases, the aver- Twin developed a combined strategy of building producer age cost per MT in any single year has been in the range of US$200–US$1,000. The investment has been covered by financial support from its Fairtrade buyer partners and by charitable funding. However, Twin’s mission to support pro- 146 In Twin’s experience, it is possible to negotiate rates of interest with alterna- ducer organizations goes beyond assuring purchases for its own business to tive or ethical lenders of 8 percent to 11 percent while local commercial banks widening and diversifying market access for the smallholder organizations with usually charge more, in the range of 14 percent to 18 percent. whom it works and increasing the value returned to them. Therefore, it regards 147 Most producer organizations with which Twin works with obtain very nar- the Producer Partnership Programme as an investment in the continued devel- row margins, of on average 3–5 cents/lb. Taking into consideration the average opment of smallholder farmers and their organizations rather than a business rate of volatility of the NY market, it is evident that developing a clear and cost. Individual buyers can invest in specific projects with smallholder organiza- responsive strategy for buying, contracting, and price fixing is essential to avoid tions, carried out as part of Twin’s Producer Partnership Programme and also losses and the risk of defaulting on loans. benefit from the program as a whole. 96 Risk and Finance in the Coffee Sector US$100,000 per applicant, for up to 90 days. Twin would FIGURE 5.33. TRIANGULAR MODEL OF sign an agreement with the producer applicant, with final TRADE FINANCE buyers paying the producer organization through Twin. Triodos This scheme worked well with few defaults; part of the Withholding of amount Y informal guarantee was mutual interest, as many produc- for repayment + interest ers were also suppliers of Cafédirect so it served them to 1 Loan 4 Payments 3 Payments maintain a relationship with Twin. amounts X minus Y amounts X This experience went on to inform a similar scheme cre- Producer / exporter Buyer / importer 2 Delivery of products ated by Triodos in 1997, offering prefinance to producer Source: Triodos International Fund Management document on Trade Fi- organizations certified by Max Havelaar (The Fairtrade nance, 2004. National Initiative of The Netherlands, Switzerland, and Germany).149 This was developed into their overall approach to lending using the triangular model of trade During periods of high prices and high price volatility, finance, whereby credit is extended to smallholder organi- some producer organizations Twin has worked with have zations against contracts, paid by the buyer on delivery experienced defaults, with members not delivering com- of the coffee directly to the lender, who in turn pays the mitted coffee. Such defaults are usually caused by sudden organization minus loan repayments and interest. price rises, when producer organizations have long-term fixed price contracts with buyers in place or have fixed the Growth. Twin’s work on facilitating lending for trade price for open contracts in advance but have not yet col- finance increased substantially from 2004 onwards. The lected the coffee to fulfill these contracts. Volatility in differ- backdrop to this increase was the continued growth in entials can also have an impact; for example, in 2008/09, sales of Fairtrade-certified coffee in the United Kingdom the local buying price in Peru increased significantly and a steady rise in the international coffee price, which during the season, responding to increased demand for increased the finance needs of producer organizations. In Peruvian washed Arabica (triggered by unusually high dif- order to respond to the increased demand, Twin devel- ferentials in Colombia, where supplies were less than antic- oped strategic relationships with social lenders to imple- ipated). Defaults have also occurred in situations where an ment the triangular model of trade finance described organization has grown too quickly and lacks the infra- above and illustrated in figure 5.33. structure, and financial and management capacity to meet its commitments. The same is true when it has diversified Where the risk of lending directly to a producer organiza- and is making the mistake of using short-term finance to tion has been considered too high, Twin has sometimes lent invest in projects with a long-term projected return.151 from its own funds and born the risk. In these cases, Twin has some procedures in place for risk management by lend- Twin’s response is mainly preemptive, including work ing incrementally (for example, prefinance is only provided done through its price risk management program to help for a second container load (between 18 and 20 MT) when producer organizations be aware of the risks associated proof is provided that coffee for at least one container is with certain types of contracts, and its work on general stored in the warehouse) with close monitoring and on-the- management and organizational support. When defaults ground contact through its producer partnership staff.150 occur on Twin Trading’s own purchases, the usual 151 Differentials are fluctuating values (in cents/lb), determined by market specifics, 149 See www.triodos.com. that link prices for physical (that is, green) coffee with those on the futures markets of 150 Twin’s producer partnership team includes associates who are based in the New York (Arabica) or London (Robusta). In this context, open contracts are those United Kingdom, United States, and in producer countries in Latin America where all conditions, including quality, delivery, and the differential, have been stipu- and Africa, employed full-time or for a number of days per year on specific lated except the actual price, which will be fixed, at a time and in a manner laid down projects. Their time is covered by project funding and their expertise includes in the contract, against a given delivery month of the futures market concerned. The organizational strengthening, quality assurance, marketing, business, and certi- combination differential/futures price then gives the final sales price FOB port of fication support, and price risk management. shipment. Such contracts are known as price to be fixed (PTBF) contracts. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 97 approach is to continue working with the organization the viability of its business, the lender is usually more will- and recoup losses through future business. In some cases, ing to offer working capital for the season or longer-term Twin has been “the first in and the last out,” acting as an loans for investment. This can be based on the producer advocate for the organization in negotiations with buyers organization’s business plan, assets, or purchase inten- or banks to find a solution, and offering prefinance for tions from a regular buyer or on a combination of these. the new season in order to support the organization and However, even where trust has been established, lenders inspire the trust of other buyers and lenders. may still require additional assurances of the producer organizations’ future cash flow. In such cases, Twin has In 2004, Twin Trading lent just over US$1 million in pre- continued to facilitate longer-term loans, by providing a finance and its contracts were used as guarantees for a fur- repayment mechanism against existing contracts between ther US$1 million lent by ethical lenders. This increased Twin Trading and the borrower. year-on-year; for example, in the period October 2005– September 2006, Twin Trading facilitated lending of For example, in 2005, Twin gave support to the coffee and US$3.2 million of which US$577,561 was from Twin cocoa cooperative union COCLA in Peru to access a loan Trading and the rest through third party lenders. This facility from Shared Interest to invest in cocoa processing increased to US$3.9 million in 2007–08 and US$4.1 facilities. This loan was reimbursed through regular pay- million in 2011/12 in line with increasing international ments deducted from Twin Trading contracts. In 2006, coffee prices. In 2012/13, the total was approximately Twin supported arrangements with Shared Interest to US$3.2 million and in 2013/14, US$3.5 million. offer term loan facilities to Gumutindo, a coffee coopera- tive in Uganda, to refurbish its factory and warehouse. Support to lenders. Lenders face challenges (in particular Security for the loan was provided in part by coopera- when they are newly established or new to the coffee busi- tive assets and also by future contract commitments from ness) to effectively monitor and support the performance Twin Trading; Twin also offered a guarantee of 50 per- of their smallholder clients and to understand the dynam- cent of the loan value. The loan was repaid over a period ics of the coffee market and how this will affect their of 5 years by deducting repayments from Gumutindo’s exposure to risk. Twin’s support to lenders has included: coffee contracts with Twin Trading. providing information on producer organizations, accom- panying lenders on client visits, and delivering technical Although these kinds of loans are needed and have worked assistance to producer clients. effectively, it is important to recognize that the repayment schedule can place a strain on a producer organization, Twin has also worked to help lenders understand the risks in particular one that is growing and needs to reinvest in associated with different kinds of contracts; traditionally its business. One of the challenges is the unpredictabil- banks have requested contracts stating a fixed price. Twin ity of the international coffee price during the repayment has worked with some lenders to promote the use of price period; when the international coffee price is below the to be fixed (PTBF) or open contracts, as under certain Fairtrade minimum these repayments are not difficult market conditions these can be attractive for producer to manage, but it is more challenging in periods of high organizations (but only if the principle is well understood prices when trading margins narrow due to higher prices and pricing decisions are taken in an informed and disci- prevailing in the domestic coffee market. plined manner). In some cases, buyers have also been will- ing to sign contracts that provide a guaranteed sale and so are helpful for the seller to raise finance, but in which both FACILITATING TRADE FINANCE WITH LOCAL COMMERCIAL BANKS price and differential will be fixed at a later date. Most of Twin’s work has focused on collaborating with social lenders to make trade finance accessible to small- LONGER-TERM LOANS holder organizations. In some cases, however, Twin has In Twin’s experience, once a producer organization has explored the possibility of collaborating with local com- established a relationship with a lender and demonstrated mercial banks through a system of internationally-provided 98 Risk and Finance in the Coffee Sector guarantees. This model was trialed by Twin, Triodos, Gumutindo, the coffee cooperative in Uganda, is an and Rabobank in Ghana in 1995/96, whereby Triodos example of an organization that began by working with Fonds and Triodos-Doen lent money through Rabo- ethical lenders and has recently started borrowing from bank to a local bank. This money was used to leverage a local commercial bank. Although the cost of finance is loans from the local bank to the cocoa cooperative union higher (at 17.5 percent), this support to their cash flow Kuapa Kokoo on a ratio of 1:5, meaning that every US$1 has enabled them to increase the volumes of coffee col- of guarantee secured US$5 of finance, with a first-loss lected from its members. They found that depending only agreement in place. Twin’s longstanding relationship with on prefinance provided by international lenders limited Kuapa Kokoo helped to negotiate this arrangement and their operations, in particular if the NY price (and there- inspire the trust of the local bank. Twin explored trial- fore the local buying price) went up during the course of ing a similar approach with coffee organizations in Cen- the season. The current facility from the local bank is for tral America but found that there was insufficient interest working capital and is not linked to contracts, although from local banks to collaborate in this way.152 evidence was required of past and anticipated sales; the next step will be to explore the possibility of pre-financing In some contexts, the engagement of a producer organi- contracts, in either local currency or US dollars (borrow- zation with international financial institutions or regular ing in dollars would be at more a competitive interest rate, Fairtrade buyers has provided informal and formal guar- equivalent to that offered by alternative lenders). antees to local banks and has permitted producer organi- zations to access lending at more favorable interest rates. Gumutindo sees this development as the latest evolution However, the possibility and desirability of engaging with in their relationship with lenders. It began by borrow- the local financial sector depends in part on the local ing directly from buyers, including Twin Trading, when banking system itself and the political framework. For their business was first launched in 1999, and it then example, in Mexico it has historically been more common developed relationships with two ethical lenders over the to access credit through government-supported schemes past 12 years. This enabled them to build a solid busi- or, more recently, alternative financial entities, such as a ness; now, having used the local bank for nearly all of Sociedad Financiera de Objetivo Multiple153 (SOFOM), their local banking services since 1998, the combination rather than through commercial banks. of their track record as an exporter and a borrower and the existing relationship with the local bank is giving them There are some contexts in which producer organizations the opportunity to grow further. Another advantage of work with local banks, even if interest rates are higher than working with local banks identified by Gumutindo is the those offered by alternative lenders, due to the volume opportunity to develop trust through frequent face-to-face and nature of their business. For example, one Robusta contact, something that can be more difficult to achieve in producer organization working with Twin in Tanzania relationships with international lenders. borrows locally at rates of 14–18 percent in order to be able to collect on average 5,000 MT from its members; it has explored working with international social lenders but FACILITATING LENDING TO A PRODUCER COOPERATIVE: AN EXAMPLE FROM THE found that it was not able to agree enough advance export DEMOCRATIC REPUBLIC OF CONGO contracts to use as collateral for a loan. In 2009, Twin started working with the smallholder farmer group Sopacdi in the Eastern Highlands of the DRC through a three-year funded project. Together with 152 In this context, first-loss refers to a socially- and environmentally-driven credit enhancement provided by an investor or grant-maker who agrees to bear the coffee roaster Finlays and the supermarket chain any first loss on an investment in order to catalyze the participation of co-inves- Sainsbury’s, Twin developed a single origin coffee from tors that otherwise would not have entered the deal. Sourced from The Global this cooperative for consumers in the United Kingdom. Impact Investing Network. Twin worked with Sopacdi to strengthen and invest in all 153 A SOFOM is a financial entity which may be regulated or unregulated and exists primarily to facilitate lending; clients can invest their own money in the aspects of their operations, including: farm rehabilita- fund and borrow against their deposits. tion, quality management, infrastructure, procurement of A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 99 equipment and buying procedures, processing methods, coffee in 2012. In the same period, Sopacdi’s differential governance and management capacity, marketing strat- went from zero to +92 cents/lb versus New York, thereby egy, and training on price risk management and interna- more than doubling the farm gate price. During this time, tional trade. However, operating in the DRC poses several the organization gained both organic and Fairtrade certi- challenges, including the lack of formal banking options fication and increased its membership from 284 to 3,200 or a regulatory framework for contract enforcement. This, farmers. Today, Sopacdi has 5,600 members. Demand for combined with security issues and the relative inexperi- Sopacdi washed Arabica exceeded supply in the 2012/13 ence of the producer organization, meant that a tailored season and volumes in 2013/14 reached 324 MT. approach was required. The work in DRC demonstrates the need for a holistic For the first two years, Twin worked closely with Sopacdi approach, in particular when working with organizations to build its financial management capacity, at the same that are new to the market and/or operate in challenging time marketing their coffee in European and U.S. mar- circumstances. The work with Sopacdi took into consid- kets. Support to financial systems included close accom- eration the key requirements for the long-term success of paniment by Twin Producer Partnership Programme a producer organization, which would contribute to them staff on the ground to install software and book-keeping becoming both a reliable supplier and a credible borrower systems and monitor the use of these during the season. in their own right. Root Capital and Alterfin provided working capital dur- ing this period, using the contracts with Twin Trading As this example shows, this involves building the capacity and other buyers as guarantees. Finance for export was of the cooperative to procure, process, and export coffee provided through Twin Trading against specific contracts, in a sustainable and reliable way; to continue to improve and Twin Trading bore the risk for these loans. During the quality of their coffee in order to generate higher this time, Twin’s Producer Partnership Programme team farmer incomes; and to build relationships in a steady and closely monitored performance, making weekly visits to sustainable way between lenders, producers, and buyers, review prices paid to farmers and ensure the money was building trust and mutual respect. Additionally, even in being used to purchase coffee, reporting back to Root a challenging environment like the DRC, such organiza- Capital every 1–2 months. tions can over time also build successful relationships with lenders if producer organizations are given the support to After this initial 2-year trial period, Root Capital and other manage their enterprises effectively, build strong coopera- lenders felt confident in lending export finance directly, tives with the support of their members, and access higher rather than going through Twin Trading, with loans made value and stable markets.155 against contracts with Twin Trading and other buyers. In addition, in 2011–12, Twin together with Oxfam Belgium SUMMARY OF APPROACH AND and the micro-lender Alterfin developed an agreement to LESSONS LEARNED jointly offer trade finance to Sopacdi against contracts Twin’s position in the market and its network of relation- with Twin Trading for Oxfam and other buyers. Twin ships has enabled it to link and broker trust between buy- continues to accompany lenders on twice-yearly visits ers, producer organizations, and lenders. Twin’s role in to the Sopacdi, and carries out business reviews every facilitating lending has been one of building relationships 6 months. 154 and mutual understanding along the supply chain and helping to strengthen capacity where needed. Despite the challenging circumstances in which pro- ducer organizations in DRC are operating, there have to date been no defaults on contracts. Sopacdi increased its export volume from 10 MT in 2008 to 171.6 MT of 155 The Producer Partnership Programme investment made by Twin per MT in Sopacdi so far has been approximately US$1,500/MT, based on the total volumes traded to date. However, as volumes continue to grow this average cost 154 See www.alterfin.be/en. of investment will diminish over time. 100 Risk and Finance in the Coffee Sector Facilitating market access. Twin’s work on promot- Recognizing the needs of lenders. Most recently, ing access to finance for smallholders cannot be sepa- Twin has worked with lenders to develop their risk assess- rated from that on trade facilitation and its support for ment and monitoring tools and has provided information investment in processing facilities or quality management. that is relevant to their risk management on the func- Buyers who are willing to commit to buying ahead of tioning of the coffee market and on local market condi- the season and/or year-on-year, or who are prepared to tions in the countries where their clients are operating. engage with less experienced producer organizations can Lenders have supported Twin’s activities in price risk offer a crucial entry point for such groups to access trade management because they recognize the value that such finance and international markets. training for producer organizations brings to their own risk management.156 Long-term relationships. In Twin’s experience, the development of long-term relationships with both buyers CASE STUDY 19: and lenders underpins the progress of smallholder producer organizations. In some cases, it has been possible for pro- EVOLVING SUPPLY CHAIN ducer organizations to secure finance earlier in the season MANAGEMENT: AN EXAMPLE against letters of intent to buy from regular customers, rather FROM CHINA157 than signed contracts. In some instances, the promotion OVERVIEW of long-term relationships between lenders and producer This case study demonstrates the importance of building organizations has also led from access to just trade finance to trust through value chain partnerships, leading to value the provision of working capital and/or longer-term loans. chain development and sustainability. An anchor buyer, in this case Nestlé-China, assists with extension advice Monitoring and technical assistance. Some lenders and enables willing and qualifying smallholders to indi- can make funds available for technical assistance to invest vidually forward sell some of their crop. The conclusion in partner organizations. Twin’s experience indicates that is that once individual smallholders realize the advan- working with partners on the ground that have longstand- tages of being part of a particular supply chain they will ing relationships with producer groups or that are imple- abide by their obligations, while holding guaranteed sales menting funded producer support programs has helped contracts at the same time allows them to become more lenders to assess the risks associated with lending to spe- “bankable.” The lesson is that this requires long-term cific organizations and to resolve any issues as they arise. commitment and, in this case, that farmer aggregation It can be of value for lenders to undertake due diligence is not necessarily always a prerequisite. But aggregation visits along with such partner organizations in order to is probably the answer where individual grower volumes develop a joint understanding of the client group and any are too small, provided, of course, that such entities can relevant risks. These partner organizations can also assist demonstrate sufficient advantages to ensure both loyalty with ongoing monitoring and support. and commitment. Building financial management capacity. The work Twin has carried out to strengthen the capacity of 156 Twin began its work on price risk management in 1997. To date, 284 organi- producer organizations—in particular, in business plan- zations in Latin America have taken part in price risk management workshops, ning, management of cash flow as well as coffee procure- of which 162 are situated in Mexico, Central America, and the Caribbean (Mexico, Nicaragua, Guatemala, El Salvador, Honduras, Costa Rica, Domini- ment and pricing strategies—has laid the ground for can Republic) and 122 in South America (Peru, Ecuador, Bolivia, Brazil). In better credit management and clearer financial reporting Africa, Twin has been conducting workshops and giving direct support to small- to lenders. Other lenders have invested in their own train- holder coffee organizations on this topic since 2008 in Uganda, DRC, Malawi, ing programs in financial management because financial Tanzania, and Rwanda as part of its wider support to develop their sales and marketing. management capacity is an essential requirement for 157 This case study has been made possible by the cooperation of Nestlé-China, accessing and managing loans, along with quality man- with particular thanks due to Mr. Wouter De Smet of Nestlé Agricultural Ser- agement, good governance, and market access. vices in Yunnan Province. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 101 FIGURE 5.34. CHINA COFFEE DEVELOPMENT 2000–13 (MTs PA*) 90000 Yunnan production China imports China exports 80000 70000 60000 50000 40000 30000 20000 10000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Yunnan Production (Green Bean), Nestlé-China; China Import/Export (All forms of coffee): ICO (2013 n/a). *PA = per annum. BACKGROUND 70,000 and 80,000 MT, but production is expected to rise With its population of some 1.35 billion people, China sharply in future as trees mature; indeed, well established is often viewed as a potential “game changer” in terms growers already average a hefty 2.25 MT per ha. The cur- of expanding global coffee consumption, yet the coun- rent government target is to reach 167,000 ha planted to try’s potential to quickly become a major coffee producer coffee, while local estimates put the total potential pro- is sometimes ignored. As a rare example of this poten- duction in the different prefectures of Yunnan Province at tial, Nestlé-China evolved from relying almost exclusively about 300,000 MT. This suggests that within a relatively on Arabica coffee imports in 1991 to 100 percent local short period of time China will become the single largest procurement from 1997 onwards. Coffee production producer of Washed Arabica in Asia, thereby leapfrog- in China dates back to 1900 but was not in any sense ging over many current producers in Africa and Latin seriously encouraged until 1988 when the Chinese gov- America as well.159 In 2012, exports exceeded 1 million ernment, with support from the UN Development Pro- bags for the first time, while China also imports around 1 gramme (UNDP) and Nestlé-China, initiated a significant million bags annually, which is mainly Robusta for blend- development in Yunnan Province, with the total planted ing purposes. area growing from basically nothing to about 8,000 ha by 1998. Today, Yunan is easily China’s most significant cof- Nestlé-China dominates the domestic market for solu- fee growing province, accounting for about 95 percent of ble coffee and 3-in-1 products,160 but there is a growing total current production. number of manufacturers producing roasted and ground coffee as consumer interest in coffee is on the rise in Arabica, mainly Catimor and all wet processed, is China.161 grown on terraces in hilly terrain at altitudes of 800 to 1,200 metres with a currently planted area of around 104,000 ha (including substantial numbers of immature 159 Many growers process coffee to the green bean stage themselves on their trees.158 Projected output for the 2014 crop year is between farms or through contract milling of parchment. They also supply fresh cherry to collectors and traders who utilize wet-processing equipment. 160 3-in-1 coffee refers to ready-to-drink products, usually delivered in powered 158 In the past four years alone the area planted to coffee in Yunnan Province has form via single serve sachets and containing coffee with whitener and sweetener. increased from about 29,000 ha to about 104,000 ha. 161 3-in 1-products are usually a mixture of soluble coffee, coffee creamer, and sugar. 102 Risk and Finance in the Coffee Sector BRIEF SECTOR OVERVIEW or by offering property (usually houses) as collateral.165 Production was initially state-driven, but not all state-owned The use of bank accounts is increasing, and there is evi- plantations weathered the 2002/03 coffee crisis. This led dence that some growers with proven track records as sup- to much of the land being parcelled up and distributed pliers (for example, to companies such as Nestlé-China) between employees, companies, and/or businessmen who are able to obtain loans. Long-term agricultural invest- purchased or leased some areas, and by local farm workers ment finance is more difficult to obtain and is expensive. who simply occupied portions to maintain alongside their own traditional farming enterprises. As a result, while in Moves toward sustainable coffee farming through veri- some areas growers still lack formal ownership, they oper- fication and certification and government initiatives to ate and manage their coffee farms as would any tenant or promote centralized wet-processing units are promoting smallholder.162 Production in the Dehong/Lincang prefec- farmer aggregation into cooperatives. This is meeting tures is however still a combination of parastatal and private with mixed success, however, as farmers seemingly pre- growers, with two companies operating core plantations fer to operate individually, perhaps reflecting past experi- and collecting fresh cherry from surrounding out-growers ences with aggregation efforts. As has been seen in other they support with seedlings and, occasionally, fertiliser. Else- countries there is also the risk that collectors or middle- where in Yunnan Province coffee is mostly a smallholder men create “cooperatives” to benefit from potential pre- crop with 74 percent of growers having less than 3 ha, and miums for certified coffee, something that requires strict often much less. In addition, there are a number of large vigilance through sustainability standards. commercial plantations.163 The Chinese coffee sector is being progressively liberalised with a mixture of domestic NESTLÉ AGRICULTURAL SERVICES and international traders/processors, exporters and import- Nestlé Agricultural Services (NAS) has built a network of ers, private and state-owned firms, and a growing number recognised suppliers, mostly individual farmers, who ben- of soluble and R&G manufacturers.164 efit from NAS training, provision of extension advice, and sale of subsidized coffee seeds. FARMER SUPPORT Grower support, extension, and training is a mixture of NAS is dedicated to broad farmer support in the countries public and private initiatives, mostly organised through where Nestlé operates processing plants; in Yunnan Prov- government county coffee offices and coffee associations. ince, NAS operates an extensive research and develop- Levels of support vary, but to encourage new plantings, ment coffee farm to compare and test different varieties. It some prefecture or local government authorities provide also helps demonstrate modern coffee farming practices, some subsidies based on the area planted to coffee or the water-efficient wet processing, anti-pollution or water san- number of seedlings purchased. Companies such as Nestlé- itation measures, and good farming practices. Training China produce and subsidize the sale of seeds for ease of includes provision of “farm books” for farmers to record transport over large distances in mountainous terrain. income as well as expenditure on farm inputs, labor, and other expenses, so as to promote an understanding that Individual small farms can access short term credit from coffee is a business and farmers must know their cost of rural credit banks either as a group, through connections, production. NAS coffee services are demand-driven and are available to both Nestlé-China coffee suppliers and 162 Land ownership in China is separate from land use, with land either owned non-suppliers alike. In this regard, Nestlé-China has signed by government or by rural collective economic organizations. Land use rights a memorandum of understanding with the Pu’er Prefec- vary with the purpose of the land. The Chinese government is, however, insti- tuting guaranteed 30-year land rights to encourage longer-term farm invest- ture in Yunnan Province to support coffee development: ment. Nestlé-China suppliers have to provide official land use certificates. Anyone can submit a request for training, but preference 163 Yunnan Province is divided into 16 Prefectures, each with its own local gov- ernment. Coffee is grown in about 10 of these, but the main coffee areas are in Pu’er, Lincang, Baoshan, Dehong, Xishuanbanna, and Wenshan. 165 Large companies and plantations can offer land as collateral but not small 164 Individual smallholders are tax exempt. Commercial growers pay income farms. However, a recent central government policy decision to extend this abil- tax, and traders are subject to income tax, value-added tax, and local taxes. ity to individual farmers promises to address this. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 103 is given to groups of at least 10 persons. This approach day (Mondays and Thursdays) by mobile phone to all has enabled Nestlé-China to link smallholders, village registered suppliers and are posted at the entrance to the communities, and plantation owners to its supply chain. purchasing station. However, due to the rapidly expanding area under coffee and the growing number of suppliers, the intention is to Nestlé-China has faced challenges stemming from this focus more on members of Nestlé-China’s 4C166 Units. In approach to pricing and to delivery from farmers. As pur- fact, commencing with the 2014/15 season, Nestlé-China chases grew, so did the number of suppliers, making it will only purchase so-called 4C-compliant167 coffee as part increasingly difficult to handle all arrivals at the Simao of its undertakings under the Nescafé Plan. Nestlé-China buying station within the same day, and at peak times has also concluded an agreement with a fertilizer com- sometimes not even within a few days. Furthermore, pany to provide training on best fertilizing practices and growers from more distant areas could even find them- to supply fertilizers at a discount to NAS 4C Unit mem- selves unable to deliver coffee during the valid period of bers. This includes establishing a distribution warehouse a given reference price, leading to disappointment if, on close to Nestlé’s Simao buying station, enabling farmers to arrival, they found the price had dropped. collect fertilizers after delivering coffee. To address both issues, Nestlé-China in 2007/08 introduced Specific additional training is also provided to farmers prescheduled delivery contracts that allow growers to com- who are selling their coffee to Nestlé-China. This train- mit a quantity for forward delivery each time a reference ing includes Nestlé’s quality requirements as the company price is announced. This is subject to a maximum volume accepts only specific qualities. Growers deliver green bean per contract and five or six such contracts during a season, to the Nestlé buying station where the quality is assessed depending on the capacity of the grower concerned. The and coffee is either accepted or rejected. There is a pen- delivery date is set by mutual agreement and on arrival the alty system for both too high moisture content or defect coffee is handled separately and within the day. count, while above-average quality warrants a bonus Sixteen contracts were signed in that initial season, climbing incentive. This type of “positive quality control” encour- to 78 by the 2012/13 season. Currently, all 4C-compliant ages farmers to improve the quality they deliver and the growers qualify automatically. Failure to deliver as per con- Nestlé experience is that, over the years, quality in fact has tract disqualifies the producer from supplying Nestlé-China, improved. However, constantly growing numbers of new but to date, the compliance record is exemplary, something suppliers and variable weather conditions do mean that Nestlé-China attributes to its close grower relationships. coffee continues to be rejected as well. In instances where growers cannot meet an agreed deliv- ery date, the contract will be rearranged by mutual agree- EVOLVING APPROACH TO ment provided the delivery takes place before season’s end, SUPPLY CHAIN MANAGEMENT in which case the original reference price is maintained. Nestlé-China twice weekly announces a reference price In theory, growers should commit only already-harvested for both conventional and 4C-compliant coffee based on coffee, but in practice this is not always the case and this the New York-settled price of the previous day. Interested stricture is not stringently observed because, realistically, it farmers have been trained in how to convert U.S. cents/lb is impossible to verify this during the harvest season; experi- prices into local currency and are familiar with the Nestlé ence to date also suggests it is not essential to do so. price calculation. Price announcements are sent on the The benefit of this approach for growers is that during the 166 4C refers to The 4C Association which includes a code of conduct and sup- season, not only can they secure a sale when they consider porting practices and verification. For more detail, see http://www.4c-coffee- the day’s price attractive, but they can also take advantage association.org/. of any price spikes that might occur. At the same time, lim- 167 4C or The Common Code for the Coffee Community is a mainstream base- iting the volume per contract and requiring that conclud- standard for sustainable coffee production that relies on verification rather than certification. The Nescafé Plan is a global Nestlé undertaking that supports ing such contracts be spread over a season ensures growers responsible farming, production, and consumption of coffee. do not commit an entire harvest on a single price point. 104 Risk and Finance in the Coffee Sector Conclusion. The Nestlé-China approach is interesting for BOX 5.6. HIGH LEVEL PROFILE OF OLAMa a number of reasons. Like the international trade in coffee, Olam International is an agri-business operating in it is based on mutual trust. Building trust takes time, but 65 countries. It works within value chains to identify and Nestlé-China has shown it can be done as have the indi- implement measures to grow responsibly as well as to sus- vidual smallholders, who have abided by their obligations tainably deliver products. In 2010, Olam introduced The because they realise the advantages associated with being Olam Livelihood Charter, which focuses on eight core areas: part of this supply chain. Growers can obtain a ready sales 1) finance, 2) improved yield, 3) labor practices, 4) market price (and the buyer an assured supply) while also retaining access, 5) quality, 6) traceability, 7) social investment, and the ability to benefit from subsequent price rises, as they are 8) environmental impact required to spread such sales over the course of a season. Olam has been operating in Côte d’Ivoire since 1994 and currently works with over 85,000 farmers in the country With secure sales in hand growers become more “bank- through partnerships with more than 1,000 cooperatives. able,” saving them from having to rely on expensive infor- It is one of the largest exporters of cocoa, coffee, cashew, cotton, and wood products from Côte d’Ivoire. For its mal credit while also avoiding forced early season sales coffee operations, the company takes an integrated value due to lack of ready cash. For its part, Nestlé-China has chain approach with customers, working to ensure full been able to continue expanding its purchases of quality traceability from origination to delivery. coffee, and keep up with growing demand, by proactively providing extension services to farmers that include seeds a More information on OLAM and its operations and its Livelihood Char- of superior varieties and training in good agricultural ter is available at http://olamgroup.com. practices, particularly as these refer to coffee and with a focus also on coffee quality. Finally, by collaborating with local government in terms of scheduling and providing Response: In 2012, Olam began a three-part livelihood support to farmers, Nestlé-China has enabled extension support program for local farmers and growers that would to be delivered in an efficient and optimized way, maxi- directly and indirectly support its supply chain for coffee. mizing the impact and the number of farmers reached. This program aimed to increase the volumes and the qual- ity of production in Cote D’Ivoire. Three parts comprise Clearly, to create this kind of system requires resources, this program: 1) introduction of good agricultural prac- long-term commitment, and an “anchor buyer.” Neverthe- tices to cooperatives in order to access better technologies less, in theory there are no reasons why this cannot function and management techniques; 2) asset building for farm- elsewhere provided farmers see real advantages in being ers and cooperatives; and 3) rejuvenation of coffee trees part of such a supply chain and therefore will not easily and farms. Providing access to finance was one of the key risk being excluded by reason of default. Where individual mechanisms within this program for increasing the vol- growers lack volume, the answer probably lies in farmer ume and quality of coffee available to Outspan. aggregation, provided such entities can demonstrate suf- ficient advantages to ensure both loyalty and commitment. BACKGROUND From 2000 to 2010, Robusta prices were both volatile CASE STUDY 20: EXTENDING and experiencing significant declines. Ivorian farmers ACCESS TO FINANCE struggled to remain afloat during this period, as the lower THROUGH THE USE OF prices threatened their viability. Given this price volatility, farmers began to limit investment in their operations and SUPPLY CHAINS neglect their farms by choosing not to replant older planta- Objective: In light of declining coffee yields and qual- tions; this ultimately lowered yields and quality, resulting in ity in Cote d’Ivoire, Olam International, through its local even lower prices. Given that farmers did not have access subsidiary Outspan SA, sought to maintain its supply of to financial risk management instruments, they were forced high-quality coffee in Cote d’Ivoire by supporting farmers to manage price risk through suboptimal management and cooperatives in its coffee supply chain. techniques, such as diversification of crops, and so on. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 105 FIGURE 5.35. OLAM’s SUPPLY CHAIN/VALUE CHAIN APPROACH Planter Pisteurs/ Particulars/ LBAs/ Exporter • Harvesting of ripe Cooperatives Cooperatives Cooperatives coffee cherries • Buys the bush • Planters deliver • Particulars charge • Collects the coffee • Drying of coffee directly to the fixed fee for hulled cherries cherries • Cleans and cooperative or hulling the coffee (bush coffee) or pisteurs collect buys from the grades the coffee • Selling to • Cooperatives pisteurs/ the dried cherries pisteurs • Final exports have their own cooperatives as • Payment made machines, thus • Supplies to the cherries or for cherries or helping the exporter stocking hulled coffee farmers Also during this period, cooperatives did not have the Outspan’s program needed to break the vicious cycle necessary funds to purchase the infrastructure to hull created by poor yields, high production costs, and expo- their own coffee, which meant they were largely depen- sure to risk. This required that Outspan take a holistic dent on third-party hullers whose processing resulted in approach that addressed the challenges within the supply lower quality coffee at a higher cost. This led to a drop in chain, beginning with production, through to processing, the national coffee crop from 350,000 MT in 2000 to the and finally to marketing. By supporting the whole supply current crop of around 100,000 MT, which has seriously chain, the Outspan program would hopefully guarantee impacted the ability of Outspan to access and trade cof- better supply and quality of production. Cooperatives fee of sufficient quality in the quantities it desires. It also were critical to the program’s success as they enabled negatively impacted the ability of farmers to get adequate farmer groups to come together and get better value for finance to invest in their operations. their produce compared to selling it directly to LBAs. However, before this program, these cooperatives could not provide and farmers could not access other services or ACTION finance from exporters. There were three primary project Given its desire to protect its access to high-quality cof- activities: farmer training, asset financing, and promotion fee (and thus its supply chain) while supporting OLAM’s of high-yielding varieties through coffee rejuvenation. Livelihood Charter, Outspan introduced a holistic pro- gram that would allow farmers to produce larger vol- umes of coffee of better quality. This required farmers FARMER TRAINING both to make appropriate agricultural decisions and be Outspan carried out farmer training that focused on best able to borrow the capital necessary to invest in their practices at the production end of the supply chain, which operations. The program therefore had to address a lack could improve yields and assist farmers in getting higher of finance for asset building, along with price risk and prices. The best practices covered in the training were yield risk. As such, Outspan chose to focus on building primarily in the areas of farm management and related farmer/cooperative capabilities and providing these to post-harvest practices. OLAM developed material and groups with the necessary resources to be able to operate organized training sessions to communicate these prac- on a sustainable basis. tices to farmers. Cooperatives were selected based on their organizational strength, production volumes, and openness to innovation. Farmer selection was conducted APPROACH by each cooperative and the training sessions provided a Before this initiative was introduced in 2012, there was mix of classroom and on-field training. The main activi- very limited involvement of exporters in the supply chain. ties were capacity building around good agricultural prac- In general, exporter participation was limited to pre- tices in order to improve the quality of coffee and yields. financing the licensed buying agents (LBAs) and coop- The activities under this umbrella included training on eratives for their working capital requirement and buying good agricultural practices, use of model farms to explain bush coffee from them. Outspan looked to carry out the practical operations, and the dissemination of post- program by providing direct support to farmers and coop- ers explaining good agricultural practices. The training eratives in the supply chain. 106 Risk and Finance in the Coffee Sector typically covered one or more of the following topics: post part of their land with these higher yielding varieties. harvesting practices, good storage practices, coffee defect This work was carried out with 20 cooperatives per year control, rain water harvesting, use of fertilizers and pesti- in two phases: September 2012–June 2013, and Septem- cides, and farm preparation for planting ber 2013–June 2014. In the crop rejuvenation program, the seeds and infrastructure (bags, sickles, and water pumps) were provided on a grant basis, while the coop- ASSET FINANCING erative bore some cost of maintenance of the nurseries In order to bring down the cost of hulling and to ensure that for around 6 months. Partial cost of this maintenance was farmers and cooperatives could control for quality, the pro- reimbursed to the cooperative at the end of the crop year gram aimed to provide asset financing for hulling machines. in the form of cooperative premiums. The hope was that the farms could increase output and ensure the best outcomes for cooperatives and growers. These machines would reduce the costs of processing and OUTCOMES spare farmers and cooperatives from utilizing more expen- There has been some level of success within all three areas sive third party hullers. This work began with assessment of the project. As a result of the work on implementing of available hulling machines in the market. Following the good agricultural practices, 6,000 farmers were trained assessment, it provided asset financing to key suppliers for directly and another 20,000 farmers indirectly.168 Follow- the purchase of shortlisted machines. This was done through ing these initial years, it is hoped that 10,000 farmers can Outspan’s cooperative network in two phases: November be trained annually and that 75 percent of procurement 2012–January 2013 and November 2013–January 2014. will be derived from supplier-owned hulling machines.169 Outspan assesses the demand among the cooperatives for The program financed 61 hulling machines for 37 suppli- hulling machines at the start of the crop year. Based on ers in the fiscal year to June 30, 2013.170 In FY14, this same the numbers of hulling machines to be purchased, the program is covering 37 hulling machines for 25 suppliers. price of the machine is centrally negotiated. In general, As a result, better quality coffee has been received from each machine costs between US$2,500–4,000. These suppliers having their own hulling machines, and suppliers machines are then given to the cooperatives as material have seen better margins due to hulling charges and qual- finance. The amount is recovered from the cooperatives ity premiums. The savings to farmers and the additional in the same crop year from the deliveries made by the revenues from the new hulling machines are significant. cooperative (US$10–20/MT delivered). If the cost is not The average cost charged by third-party hullers is about recovered in one year, it gets carried forward to the follow- 25 CFA/kg (US$50/MT). Cooperatives conducting their ing year. Essentially, the finance is for 6 months but can own hulling themselves can manage 10–12 CFA/kg get carried over for 18 months. This finance is at zero cost (US$20–25/MT). This is direct additional revenue to to cooperatives. the farmer. On the quality front, old hulling machines can give outputs of anywhere between 30–50 percent. Outspan conducted a randomized that showed the aver- PROMOTION OF HIGH-YIELDING age outputs in Côte d’Ivoire were approaching 43 per- VARIETIES THROUGH COFFEE cent. The new hulling machines being given under this REJUVENATION program can give outputs between 48–52 percent. The Finally, Olam wanted to encourage farmers to rejuvenate higher outputs result in higher saleable quantities for the older plantations by planting higher-yielding varieties to improve the overall availability of coffee and the quality of that coffee. The Olam program encouraged the devel- 168 At a rough estimate, there would be 150,000 Ivorian coffee farmers, of which opment of nurseries at cooperative level and its support Outspan would be sourcing from approximately 40,000 farmers. 169 The quality of hulling machines plays a vital role in the output and quality of included the cost of setting up the nursery, seeds, moni- the coffee. Although not part of good agriculture practices, it is a critical lever to toring, and technical support. Once ready, the saplings ensure final quantity and quality of produce. were distributed to farmers to enable them to replant 170 Fiscal year for Outspan runs from July until June. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 107 farmer. Also, these machines better maintained the qual- output to other companies, Outspan only works with ity of green coffee. Hulling with these machines already cooperatives that have and maintain a track record with reduces damage to beans by 2–3 percent; this enables the company. It keeps a record of its exposures to each farmers to get quality premiums for their produce, which cooperative and depending on it’s track record and any could range from US$20–50/MT. side-selling, adjusts accordingly. Outspan also maintains robust tracking mechanisms with the cooperatives, and While the project has been largely successful with farmer only holds collateral in the form of vehicles. Finally, Out- training and hulling machine placement, success with the span provides a fair market price for purchases. Given that crop rejuvenation program has not come as easily. The its prices are competitive with the market, there is little crop rejuvenation programs required significant resources motivation for the farmer to sell elsewhere.171 in order to gain the necessary scale and given that all finance has come from Olam’s own funds, there is a limit to the size of the program. In the future, the program SUMMARY Outspan’s approach has been to work with small- and hopes to access additional funding to support its crop medium-sized suppliers, growing its business by first help- rejuvenation efforts and it is currently in discussion with ing them grow theirs. Support for initiatives that enable Conseil de Café-Cacao for a possible public-private part- its suppliers gain access to more and better quality coffee nership for crop rejuvenation. is central to this idea. This enables Outspan to earn more through both higher throughput and also better mar- LESSONS LEARNED gins. The internal accruals and the margins that Outspan In a program where Outspan invests in its supplier coop- makes from its operations are enough to support the train- eratives throughout the production cycle and only seeks ing programs and hulling machine purchases. However, to benefit from the increased throughput and quality demand for support through the coffee crop rejuvenation improvements, side-selling always remains a significant program outstrips Outspans allotted resources for crop risk. To manage the risk that cooperatives will sell their replanting. 171 These activities are primarily focused on managing the yield and quality risks. 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Gerenciamento de riscos e novos instrumentos para o financiamento do Agronegócio. Seminário de Planejamento Estratégico Empresarial. CSMIA– ABIMAQ–Outubro, 2013. CASE STUDY 13 Actuals 2013—data provided by Root Capital. Root Capital Performance Report: Q4 2013, 2 pp. CASE STUDY 14 Guidebook on African Commodity and Derivative Exchanges—African Development Bank 2013. CASE STUDY 19 “Coffee in China,” ICO Document ICC-109-12, 2013. A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 111 SUMMARY OF CASE STUDIES CONTAINED WITHIN REPORT No. Title Overview Primary Conclusions 1 The Importance of a A consideration of three countries The enabling environment plays a significant Supportive Enabling Sector and their regulatory/enabling role in determining the effectiveness of the Environment: Uganda, environments, and the resulting industry. In addition other economic activities Tanzania and Kenya —A impact on the relative success of and opportunities for supply-chain actors Comparative Case Study the coffee sector. also impact upon their decision making and ultimately on the success of the industry. 2 The Value of Regional A review of the work of the African Enabling environments can be improved when Private/Public Sector Fine Coffees Association with the industry is organized and can advocate with Initiatives: The Example specific regard to its efforts regulators for improvements. The growing role of the African Fine Coffees to advocate for the sector of AFCA in addressing regulatory barriers and Association (AFCA) and improve the regulatory pushing for improvements, both regionally and environment. nationally, is an example of how industry can effect such regulatory change. 3 Futures Markets in Coffee- A consideration of the challenges There are a number of prerequisites required Producing Countries of implementing coffee futures to ensure the success of a futures market for markets in producing countries. coffee. These include regulatory infrastructure and sufficient utilization by actors involved in the physical trade. While there is a role for such exchanges, without these prerequisites being met, newly established exchanges will struggle to survive. 4 Implementing Price Risk Examination of an innovative Improvements in communication between actors Management in the program from Rwanda that uses in the supply chain can significantly improve Rwandese Market Place technology (SMS) to improve the the management of risk. This requires creative flow of data across the supply solutions to overcome the challenges of poor chain enabling improvements communication and geographical distance. in risk management to be implemented. 5 Minimizing Price Risk Overview of capacity building of Producer associations can benefit from the use of through Variable Sales cooperatives in the use of call price risk management instruments, especially Using Call Options options to manage price risk. if supported technically and transactionally in a partnership with supply chain partners (buyers). 6 The 2012 Latin American Review of the outbreak of coffee Climate change is significantly affecting coffee- Coffee Rust Outbreak: rust disease (la roya) in Central producing areas and is likely to continue to “Black Swan” or “New America. do so. This will require producers and others Normal”? to take additional ex-ante risk management measures if they are to avoid significant losses occurring with increasing frequency. (continued) A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 113 No. Title Overview Primary Conclusions 7 Recent Experiences of Coffee Examination of the Colombian It is possible for a coordinated response between Replanting Programs in tree replanting program and its government and supply chain actors to tackle Colombia financing modalities. coffee tree replanting through the use of technical assistance, affordable and available financing, and provision of high quality inputs. However the case illustrates the complexity and cost of such an integrated approach. 8 Utilizing Technology and Consideration of the recent Innovative use of technology aligned with local “Boots on the Ground” to rollout of the Sub-K program delivery mechanisms can potentially overcome Reach New Customers in in India to expand the reach of the transaction cost barriers of dealing with India: the Sub-K Approach financial services to remote rural remote populations. However, technological populations. challenges still exist and require further work until such a system is fully proven. 9 Farmers’ Access to Credit Examination of a credit guarantee Replicating programs to expand financing for through the Use of Credit program rolled out in two African coffee sectors in different locations may result Guarantee Services: coffee-producing countries, which in very different outcomes. Experience of Coffee had different outcomes. Farmers in Ethiopia and Rwanda 10 Incorporating Price Risk Review of an innovative program Demand for risk management solutions varies, Management into the developed by a Tanzanian bank to with actors recently adversely impacted most Lending Operations of a facilitate financing to coffee clients eager for such solutions. Solutions need to be Tanzanian Bank: 2005–07 through the delivery of price flexible and include a range of measures to deal risk management training and with such risks. education. 11 Cédula de Produto Rural: A Overview of the CPR product The suitability and attractiveness of a financial Tradable Receipt in Brazil in Brazil which has assisted product will vary over time depending on the in facilitating financing to availability of competing financial products. agricultural producers and actors. However, the CPR does illustrate that a well- designed product can be utilized effectively and provide finance when other sources are not sufficiently available. 12 COMRURAL Honduras— A look at the COMRURAL Private sector banks, which may have been Crowding in Commercial project from Honduras, which reluctant to lend to the coffee sector, can be Banks through Matching encouraged private sector encouraged to expand their lending when Grants banks to provide credit to coffee productive partnership programs are in place. cooperatives through a matching Banks need to be assured that the investment grant program. to be financed is economically sound. 13 De-risking the “Missing An overview of the work of Root There is room for an expansion of financing Middle”—The Case of Capital and how they have from simple export credit to more complicated Root Capital, a Socially- managed to expand a varied set investment financing. This is an evolutionary Oriented Lending of loans to coffee cooperatives by process with trust being built up between Institution building trust and relationships lender and borrower over time—as trust grows, with cooperatives. there is increasing scope for more complicated lending to be offered. 114 Risk and Finance in the Coffee Sector No. Title Overview Primary Conclusions 14 Warehouse Receipt Systems in Review of warehouse receipt systems A warehouse receipt system must be backed the Coffee Sector: African in Africa and their utilization in by adequate financial services to facilitate Experiences providing a means for facilitating their usage. For coffee sectors, collateral financing to coffee enterprises. management in many situations offers a more flexible solution for facilitating financing. 15 The Benefits of The implementation of a price Risk management requires competent enterprises Modernizing Costa Rican risk management program by a managers to be in place and empowered to Coffee Cooperative Costa Rican cooperative and the act, if it is to be implemented in an effective COOPETARRAZU role played by management and way. For a cooperative, ensuring good members. communication and understanding of the process being implemented between board and management is critical. If implemented effectively, the enterprise has the potential to offer services to other enterprises and grow its market presence. 16 Nsangi Coffee Farmers A cautionary case study considering Aggregation alone is not sufficient to achieve Association, Uganda the risks of financing made success; rather, it is critical that cooperative to a cooperative failing to management is professional and empowered exert effective control over its to operate in a commercial manner, and operations. avoid, taking unnecessary short-term speculative decisions. Membership and the board of directors must also be trained to understand their roles, obligations, and responsibilities. 17 Strengthening the Financial Examination of how a Smallholder associations, provided with Capacity of Smallholder comprehensive technical technical training and support, can improve Businesses: The PorFin assistance program worked to their ability to financially manage their Project build the capacity of borrowers to enterprises and improve their ability to borrow. access finance from commercial lenders. However, such technical assistance programs require intensive training and are expensive to deliver. 18 Facilitating Lending to A look at Twin Trading and how There is a role and an opportunity for importers Smallholder Producer they utilized their relationship and buyers to assist their suppliers with Groups—The Twin with both producers (suppliers) improving their access to finance. Buyers often Approach and lenders to facilitate an have significant information on their suppliers expansion of finance based that they can share with financiers, and thereby on their order book with facilitate finance. Additionally, the buyer might cooperatives. use their balance sheet strength to provide supporting guarantees to encourage lenders. This is mutually beneficial to all three parties: buyer (builds the strength of their supplier); supplier (improved access to finance); and lender (access to new borrowers). (continued) A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector 115 No. Title Overview Primary Conclusions 19 Evolving Supply Chain A study in the evolving relationship This case demonstrates the opportunities for Management—An between a large buyer and a tightening the value chain with a large buyer Example From China group of smallholders in a rapidly building direct relationships with smallholders. expanding coffee sector, and how This is based on mutual benefit with buyers this relationship is strengthened by securing quality supplies (and quantity) and tightening of the value chain. smallholders accessing more affordable finance and receiving value-adding extension services to improve their productivity. 20 Extending Access to Finance A review of OLAM’s program in An excellent example of how a strong relationship through the Use of Supply Cote d’Ivoire, and their holistic between value chain participants can greatly Chains provision of technical assistance improve both management of risk, access to and finance to build a robust high finance and improvements in production. quality dedicated supply base. 116 Risk and Finance in the Coffee Sector A G R I C U LT U R E G L O B A L P R A C T I C E D I S C U S S I O N P A P E R 0 2 W O R L D B A N K G R O U P R E P O R T N U M B E R 93923-GLB 1818 H Street, NW Washington, D.C. 20433 USA Telephone: 202-473-1000 Internet: www.worldbank.org/agriculture