National Commodity Exchange – Staying Ahead of the Game

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    THE National Commodity Exchange Limited (NCEL) provides a centralized and regulated place for commodity futures trading in Pakistan.

    It has developed into a premier Commodity Exchange not only ofPakistanbut also the region, offering fully automated trading, settlement and risk management systems incorporating International Best Practices in line with global standards.

    The establishment of NCEL in the regulated sector has changed the way business is done for the benefit of the national economy, growers, intermediaries as well as the government as traditionally both agricultural commodities and gold has always been done in an informal and unregulated manner

    In a detailed interview with Ibex, Asim Jang provides a basic overview as well as dilating on related issues.

     

    Q: In simple words, what is Commodity Exchange?

    A: I will employ the example of the Sunday market to explain the concept of Commodity Exchange. A large number of buyers and sellers come and trade at such a place.

    In Commodity Exchange, you can have spot commodity exchange and Futures Commodity Exchange. The basic idea is that a large number of buyers and sellers interact and determine prices.

    The second objective of commodity exchange in an economy is to plan for the future. If you do not have futures’market, then you live in the “today” and you will not be able to plan for “tomorrow.”

    There will be no mechanism to facilitate you with an estimate as to how much crop will be harvested next year. Without a Commodity Exchange, there is no proper research in themarket. These are all the indirect benefits of a Commodity Exchange.

    Furthermore, a Commodity Exchange enables participants to anticipate risk and thus enables risk management; if you are expecting a bad harvest and the prices to go up, with the help of demand and supply positions, you will be able to hedge the disaster. Also, if one has an idea about themarket trends, one can buy now and sell in the future.

    So Commodity Exchange facilitates a plan for the future and a fair ground for buyers and sellers.

    Q: What kinds of commodities are listed in the Commodity Exchange?

    A: ‘Commodity’ implies an object of trade. Anything and everything can be traded. It is a myth that only physical things are commodities: anything which can be bought and sold can be a commodity, which includes even electricity and gas.

    So it can be said that even the services are commodities as they are being bought and sold. You have also intangible commodities like stock index, bond index, interest rate futures etc.

    In Commodity Exchanges, other than cultural commodities, there are also intangible commodities.

    Even weather derivatives are listed on Commodity Exchanges. There are also contracts of rain fall index which predicts the rain and kinds of harvest in the future; these contracts are used for insurance of different crops.

    Currently NCEL is listing IRRI-6 Rice Commodity Futures Contracts and Gold Commodity Futures Contracts. However, in the product pipeline we also have Palm Olien, Cotton Seed Oil Cake, as well as KIBOR Futures Contracts and Foreign Exchange Futures Contracts.

    Q: Who are the beneficiaries of the Commodity Exchange?

    A: The entire spectrum of economy is the beneficiary. Consider the example of a farmer: if he knows that the price of wheat after six months in forward market will be such and such, he will be able to plan for it well ahead of time. He can plan how much he wants to invest in that crop. He could have known the return before the time.

    The whole idea is that people are getting tools to make decisions for future investments. From the view point of the consumer, consider the example of DAWN bread: if the company knows that after six months their inputs will cost them such and such amount they can plan for it now and be a better company by keeping a steady supply. Otherwise they might end up having a fluctuating demand and supply graph in the balance sheet.

    The only disadvantage of having a Commodity Exchange is that it enables transparency in themarket, which can remove any monopoly powers. It is, however, good for the country.

    By transparency, I mean that if a certain hawker is selling tomatoes for Rs 10 in some part of Sind or Punjab, there could be another who would be selling the same for Rs 80 inKarachi.

    As people are not generally aware of the prices in different regions, this will go unchecked. But with a Commodity Exchange there is a centralized platform which disseminates the prices, so that every one is aware of the price of tomatoes in this example. So Commodity Exchange brings a transparency in themarket and increases the competition in themarket.

    By disseminating the prices of different areas, it could also help to reduce inflation by breaking the monopolies.

    If government knows the price of some crop in the future, it can enter into a contract with other markets, thus reducing and managing their costs.

    It reduces costs because, for example, when you are procuring wheat, 40% is the storage cost, but if you are using the futuremarkets, you save this 40%.

    There are approximately, 400 mandis in Pakistan, among them 14 major. If we disseminate the prices of these mandis, consumers will know the prices in Sahiwal,Faisalabad and all other areas, and thus facilitate a lower and sensible level of prices. Our markets are not that developed at the moment and we do not know the prices of different regions.

    . If there were any indications of the future interest rates available, they could hedge the interest rate risk.

    Q: Is there any affiliation between Commodity Exchange and Stock Exchange (KSE)?

    A: Yes, but only as one of our shareholders. Our technology is very different from that which is employed in the stockmarket: our products are different and our risk management is different. In stock exchange, you trade in assets but in commodity exchange, you trade in obligations or contracts. Actually, in commodity exchange, you are buying and selling a contract and not buying and selling a physical commodity. We list contracts while in Stock Exchanges assets are listed. Furthermore, In Commodity Exchanges, it is a zero sum game, which is to say that when someone makes a profit there necessarily must be someone on the other side of the trade who is making a loss. With the Stock Market, when the price of an asset falls, all holders are adversely affected and when the price rises, all asset holders are benefiting.

    Q: What kind of people can trade in Commodity Exchange?

    A: Every business has a channel of distribution. The channel of distribution for NCEL is our brokers.

    They distribute our services and assist the clients, who are interested in trading on this Exchange by opening accounts for them. Even farmers can trade on this exchange and benefit by it but, inPakistan, due to the fact that we are still in our development and growth phase, the awareness is not that wide spread.

    Going forward, the brokers, once the benefits of the Exchange become clear, will be spreading the word to their extensive client network. To encourage this, we have taken the brokers with us when we hold our seminars in various cities of Pakistan. There, they have the opportunity to meet small traders and farmers.

    At NCEL, we believe that education is the key and that participants should be aware of the pros and cons of trading. We believe this to be part of our social obligation towards the country.

    Further, we are also providing a three-day extensive programme, run by an FSA authorized derivatives trader at our purpose built training centre, free of cost, for people who want to really understand this business. Details of this program are available on the NCEL website.

    Q: How do you list contracts in the Exchange?

    A: There is a scientific process to list contracts in the Exchange. Due to improper designs, on average, almost 80 per cent of the contracts fail globally.

    Designing a contract is an art in itself: these are designed either by sitting with the participants of spot market or with the people, who are working in value chain or by taking inputs from everyone.

    It is not possible that there be a 100 per cent agreement on a contract but we have to absorb everyone’s views and then we construct a contract.

    We have to be very careful in this regard because if a contract is not designed properly, traders would suffer losses or trading would not occur and the contract would eventually fail.

    While designing a contract we sit with people from different supply chains of a business ormarket participants. So actually, it is a very thorough and detailed process. We also have to look at the risks of inspection, quality risk, disputes and arbitration processes.

    We collect prices from all the markets. We conduct a poll every day in which millers, traders, and brokers are used to collect the prices and then we disseminate the prices to the market.

    Q: Is there any criterion for selecting a contract?

    A: Initially we have selected contracts which are easy to understand and a normal investor can easily trade on it. People should know how prices are set in themarket, cost of carry, time value of money; these concepts are still not fully understood so at this initial stage in ourmarket it is important to list standard contracts

    We are working extensively to promote these concepts and to work up a method that would allow us to price a contract.

    We have to keep in touch with the brokers for guidance on different aspects of the market — national and international aspects that affect the prices of contracts.

    We need to stay aware about all those factors in the market which affect prices of different contracts.

    Q: What are the core issues being faced by Commodity Exchange in Pakistan?

    A: The answer to this is simple, the low level of awareness about this business. People are scared of entering into this business because they lack proper knowledge. But once you have proper knowledge about the business, you can easily plan for your company’s future. And we are trying to educate people by conducting seminars at different places and, also, we are trying to introduce small contracts on the exchange so that people can be easily made aware of the procedures.

    Q: Do you have any warehouse facilities?

    A: No Commodity Exchange globally has their own warehousing facility, and generally the spotmarket warehousing infrastructure is used by the Commodity Exchange.

    Q: How do you compare National Commodity Exchange of Pakistan with those of the other countries?

    A: Technologically NCEL houses advanced infrastructure with segregation and surveillance carried out till the client level. This is taking risk management one step further that many of the global commodity exchange. Furthermore, we were perhaps one of the first Exchanges to introduce USB Key access with embedded digital certificates.

    Q: How much potential does this business have in Pakistan?

    A: There is immense potential. But it will take time. Our vision is to go down to the farm level, which will take some time. And institutions would also be required to finance the commodities in this exchange.

    Ii is my firm belief that our farmers can feed a population of 160 million people without any issue if we just look after them properly.

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