CME Europe’s Cocoa Quality Analysis - Article 5

How Independent Sampling and Grading aligned to the underlying Physical Market provide a better hedging medium

Part 1 – Sampling

The quality of cocoa beans gets a great deal of attention, and with good reason: apart from providing food-stuff suitable for consumption, the quality significantly impacts the value of cocoa deliverable under the CME Europe cocoa futures contract. If better than average in quality, the cocoa may be eligible for a premium; conversely, if lower than average in quality, discounts may be applied.

The quality of cocoa is determined by analysing a sample of beans drawn at random from a parcel. The determination, therefore, is equally dependent on the sample provided as on the analysis itself. An accurate analysis of a poorly drawn sample will provide just as imprecise results as poor analysis of an appropriately drawn sample.

Ensuring Quality of Sampling

Proper recognition of each stage of sampling, plus an understanding of the relationships between the parties involved (see our previous article on Conflicts of Interest), were key factors in the design of CME Europe Cocoa Futures.

Consequently, the contracts:

1)   apply the trade rules for sampling in terms of:

·      methods of sampling

·      amount to be drawn

·      sample amount

2)   require independent supervision of the process of:

·      drawing the sample

·      handling of the sample material

While these features help ensure the integrity of the process, CME Europe also has taken steps to keep costs as low as possible for those in the supply chain. 

Aligning Sampling to FCC Terms

The Federation of Cocoa Commerce (FCC) issues contract terms for cocoa traded in Europe.  Market participants use these terms in their physical contracts and optimally, require a hedging tool that is closely aligned to their physical needs. 

FCC terms recognise that a 2-kg sample may be used to represent a parcel of cocoa from one Bill of Lading (B/L) weighing up to 250 tonnes. CME Europe Cocoa Futures adopt this term by allowing one 2 kg grading sample to represent one lot of 10-tonnes, to up to 25 lots each weighing 10-tonnes, provided that all lots have the same origin, crop year and B/L.

When a sample of cocoa is drawn, small amounts of beans are extracted consistently but at random - called Primary samples for bags, or Incremental samples for bulk.  

The process of drawing Primary or Incremental samples is very labour intensive and time consuming. For bagged cocoa, a minimum of 30 percent of the bags must be stabbed to provide the Primary samples; for bulk cocoa, the parcel typically must be physically moved from one location to another in order to expose all of the cocoa for sampling from the moving stream. 

The process of collecting these samples results in a significant amount of extracted beans, which as a whole are called the Composite sample.

Once complete, the Composite sample then is carefully divided (‘quartered’) to provide the 2-kg grading sample for analysis. 

Greater Efficiency in Sampling

The sampling process is common to many commodities and usually must be repeated when a fresh sample is needed. CME Europe has introduced a sampling process that utilises the remaining Composite sample from the original extraction for future samples, helping to minimize costs of ongoing sampling.

Once the initial grading sample is removed for analysis, the independent supervisor bags and seals the remaining Composite sample material, which is then stored with the parcel from which it came. 

Provided the parcel represented by the Composite sample has not changed, a fresh grading sample may be obtained by quartering the remaining Composite Sample.  In addition to being cheaper than resampling, this practice better preserves the cocoa, avoiding the need to re-puncture the bags or move the bulk cocoa, which are expensive and damaging to the beans.

Use of Independent Supervisors

In addition to following the FCC’s sampling rules,  CME Europe Cocoa Futures contracts stipulate that all sampling must be conducted with an independent supervisor in attendance. The supervisor is appointed by the Registrar. 

The warehouse keeper will have no access to the grading sample, thereby minimising potential conflicts of interest. 

Moisture Testing

In some instances, upon arrival, it’s discovered that the cocoa has not been prepared properly and/or has been inappropriately shipped.  As a result, the cocoa beans may arrive damp. 

Damp cocoa results in faster deterioration of cocoa quality, and can result in physical damage to the goods.  It can also distort weight results (by virtue of loss of water when it dries), making it misrepresentative of the parcel and unfair for any prospective owner.  CME Europe recognised this issue and introduced a moisture test to address it.

The moisture test will be performed by the independent supervisor in the warehouse, while preparing the grading sample.  The test will be conducted with a SINAR LSA moisture meter, calibrated according to CME Europe standards.

Three checks will be made on the drawn cocoa; all results must fall within 0.3 percent of each other in order to be valid.  Before the Grading Sample can progress to the grading stage, the average result must be below 8 percent.

If the moisture test result registers at 8 percent or above, the owner may wish to appeal the result. The owner can appeal at his/her own cost by having an independent laboratory re-run the test, applying the International Confectionery Association (ICA) Analytical Method 43 - 1993 oven test, expressed in % m/m.  

Failure of the moisture test does not mean that the cocoa has failed grading; the owner can apply to resample the parcel when he/she and the warehousekeeper consider the cocoa to be sufficiently dry to pass the moisture test.  If more than 30 days pass since the original test, however, the parcel must be reweighed.

Independent supervision does come with a cost, but it is far outweighed by the benefits of ensuring the integrity of the sampling process – and the significant cost savings to owners that can result from of enhanced sampling and grading techniques (enabling a sample to represent 250-tonnes, use of remaining Composite for future samples).

In ‘Part 2, Grading’, we’ll explore how additional savings can be achieved in the grading process as well as through validation of the result – all while adopting the basis of the FCC analysis of cocoa and ensuring a proper relationship between the deliverable contract and the underlying physical market.

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