NATIONAL COMMODITY EXCHANGE LIMITED

The concept, the impact By SYED M. ASLAM Jan 13 - 19, 2003 Pakistan's first futures commodity market, National Commodity Exchange Limited, was incorporated on April 20, last year. However, even before its tentative commencement of business in March this year, it is in the process of changing its name to Pakistan Commodity Exchange Limited to give it an international projection. The exchange is the only company to provide a centralized and regulated place for commodity futures to be traded in Pakistan. It aims to develop into a premier Commodity Exchange not only of Pakistan but also in the region to offer fully automated trading, settlement and risk management systems comparable with international standards. The exchange will deal in the trading of commodities such as gold, wheat, rice, sugar, cotton yarn, etc. Gold will be first commodity to be traded and trading of other commodities will follow in phases. The establishment of the exchange is the continuation of economic policies of the government to stimulate investment in the country, regulate trading in commodities and document the national economy. The Karachi Stock Exchange is the largest shareholder of the exchange and holds 40 per cent of its stocks. Lahore and Islamabad stock exchanges, the remaining two bourses of the country, hold 10 per cent shares each and there are also other shareholders. The exchange has a small initial paid up capital of Rs 50 million and has successfully raised an additional Rs 260 million by giving licences to 260 brokers at a fixed amount of Rs 1 million each. This cash equity of Rs 310 million is used to develop the infrastructure necessary to accommodate the fully automated trading. OBJECTIVES The exchange aims to establish, conduct, regulate and control trade or business of futures commodity contracts within or outside Pakistan and to perform all allied and incidental functions to facilitate, setup and carry on the business of chosen commodities. It will also regulate the handling exportation from and importation of commodities into the country It also aims to maintain high standards of commercial honour and integrity, to promote and inculcate honourable practices and just and equitable principles of trade and business, to discourage and suppress malpractices, to settle and decide points of practice, disputes, questions of usage, custom and courtesy in the conduct of trade and business. One of the important objective of the exchange which would have a positive impact on exports is that it will communicate with the chambers of commerce and other mercantile and public bodies in and outside the country for the protection of the commodity trade. BENEFITS TO THE ECONOMY The Chairman and Managing Director of the Karachi Stock Exchange, Salim Chamdia and Moin Fudda respectively, are also the chairman and managing director of the first commodity exchange of the country. Mr. Fudda informed PAGE that administrative set-up and technical aspects of the exchange have already been finalized. The administrative including incorporation related formalities and membership of the first board of the exchange have already been completed. The list of single commodity and universal

contracts, the first of which will be gold, has also been decided and the system for trading are being developed. The commodity exchange though a new concept in Pakistan will provide an opportunity for the investors both local and foreign no matter wherever they are located in the world, in the futures trading of the commodities. The establishment of a centralized and regulated market place will attract investment in the futures trading to offer new venues for investment in commodities. "For instance", Mr. Fudda said, "the global gold prices have been on a rise during the last one year but the absence of the commodity exchange denied the people to invest as people has to go to Dubai to buy the commodity. If gold was traded here it would have helped the investors as well as the country to maintain gold stocks through future trading. The establishment of exchange can help Pakistan become a regional center for gold as even India does not have a commodity exchange. The fact that Pakistan will be the first country to offer futures trading in multiple commodities on the national and the international level is definitely a welcomed development indeed." Talking to PAGE, the chairman of the commodity exchange Salim Chamdia said the single biggest benefit of futures trading in commodity is that it would offer hedging in the commodity market, the main beneficiary of which will be the agriculture sector. This is an important development indeed as Pakistan still much remains an agrarian economy and the exchange will provide marketing venues of agriculture produce or derivatives in advance. Growers will benefit and so will the intermediaries. The establishment of the regulated organization in the formal sector for the first time in the country where trading of agricultural commodities and gold has always been done in an informal and unregulated manner will change the way of doing business for the benefit of the national economy, growers and intermediaries and also the government, Mr. Chamdia said. The hedging and the market-driven speculations will also bring the much needed price competition and transparency to help project Pakistan as the regional commodity exchange center to attract immense investment into the country, he added. "Futures trading in commodities enjoy an edge over investment in the stock market as it is not static but comprise commodities which though not held physically are nevertheless real." Does the buying and selling of commodities with contracts stating the quantity, unit price, description, quality and future delivery on a fixed time mean protection of growers and intermediaries? Mr. Chamdia said that though futures trading in commodities offers no remedy for price fluctuation, even wild price fluctuations, it does offer an opportunity for hedging not available previously. "Commodity trading through futures allow the buyers and sellers a hedge against price changes that may adversely affect their business to make an informed decision to better the profits or cut the losses. Thus the growers and the intermediaries would be able to sell the commodities at any time as and when the prices suit them. In addition, the inbuilt 'price discovery' mechanism in the presence of a regulated futures market and presence of speculators also offers benefits to the growers. Other elements like financiers will also help the economy." The absence of a regulated commodity exchange center in the formal and organized sector has rendered the whole process non-transparent which offers no protection to the large population of growers and producers of agricultural commodities. It has also resulted in layers upon layers of dubious dealings without any consideration of quantity, description, quality and price. The dawn of futures trading through the commodity exchange, accessible from anywhere within or outside the country with only a mouse click away, would benefit the large farming community thus been deprived of fair prices of their produce. GOLD AND COTTON YARN As mentioned above gold will the first commodity to be traded on the commodity exchange. Mr. Chamdia stressed that reducing the import duty on gold by half would help give a boost to futures trading in the commodity by entirely wiping out smuggling. "At present, gold import in the country is subjected to import duty of 1 per cent. We urge the government to reduce the duty by half per cent to 0.5 per cent and also to

allow its export at a similar rate of duty for the two-way flow of gold in the country. Cutting the duty will help wipe out the smuggling of gold entirely and will also help the government to increase its revenue. The measure would help Pakistan develop into a parallel market for gold compared to Dubai which currently enjoys the status of international gold market in the region. "The futures trading of gold in the near future will not only attract the investment in the most valued precious metal in the world but will also encourage its trading at the exchange to build-up substantial gold reserves for the country. It would help fuel the national economy as over 130 tons of gold is being imported into the country every year. It would also help abolish its smuggling, subject to reduction in duty to altogether wipe out any incentive to the smugglers, entirely to let Pakistan emerge as a parallel gold market in the region. The advantages are immense." Cotton yarn will be second commodity that will be traded on the exchange. The decision is based on the fact that Pakistan is the top exporter of cotton yarn in the world and its trading on the exchange will give it a greater exposure in the international markets for the benefit of the Pakistani economy. The futures trading of cotton yarn will give a great boost to an agrarian economy which relies heavily on cotton and where agriculture provides employment to the largest number of people. "The cotton yarn is traded in other parts of the world without benefiting the national economy and its trading on the up-coming commodity exchange would help the economy by bringing investment into the country. It will also help the growers, intermediaries and producers and the industry to benefit from the trading. We are expecting a good response from the investors, particularly foreign investors specially as far as cotton yarn trading is concern." BENEFITS TO THE INDUSTRY Futures trading in the commodities will benefit the Pakistani industries in two distinct ways. Number one, the availability of hedging market and the finances would help the cloth producers to buy the yarn at their own convenience according to their own cash liquidity. Secondly, the price discovery mechanism will also result in efficient prices to keep the production costs in check to better compete in the international markets. "Since textiles is the backbone of Pakistani economy and since cotton crop is the single biggest earner the futures trading will also result in increased exports." The open market price of individual commodities fluctuates from time to time and at times from day to day, day to day and sometimes even minute to minute. The contracts can be bought or sold prior to the delivery date thus helping a grower or an intermediary to off-load a commodity prior to the delivery date. Thus the original and seller, the hedgers, or the average investor, the speculator, can profit through the price movements. Developing a futures market will also help its counterparts in the informal and the unorganized sector to be competitive and transparent for the benefit of the agriculture in the country where growers incessantly complains about not getting the fair prices for their labour. "Sugar is one of the commodity which will ultimately be traded at the exchange. However, there may come a time that even the sugarcane would be traded to enable the growers to take advantage of the 'price discovery' mechanism to ensure prices that are fair." Asked what kind of investment would the exchange will bring into the country, Mr. Chamdia said that futures trading in commodity will help retain between 8 to 10 billion dollars annually once the exchange would be fully operational. In addition, the buying and selling of futures contracts based on price speculations take place many times during its lifetime. Trading in futures, thus, results in a much bigger economic activity then the original contract itself and in the developed commodity markets, the futures trading runs in billions of dollars daily. TECHNICAL SETUP

Karachi Stock Exchange, the biggest shareholder, will provide the technical backbone for the country's first commodity exchange. Trading will also be accommodated through the other stocks exchanges of the country Lahore and Islamabad and the universal online trading will also be accommodated online from any part of the world. There are two categories of membership, one for trading of a specific commodity and the other for trading off commodities if and when introduced at the exchange. The computerized trading system will provide market participants with online market and price discovery system ensuring the best bid and offer for all market participants. The exchange plans to provide a number of services to the brokers including trading terminals at remote places, online market information system, clearing and settlement and comprehensive risk management system. Though the risks associated with the trading of commodities; due mainly to heavy dependence on weather, global production and demand during a particular season, can never be eliminated entirely, they can certainly be minimized. The exchange will introduce an efficient clearing fund management system, monitor the exposure carried by brokers and adopt comprehensive risk management systems and practices in the commodity markets in the developed world. Taking educated risks would be possible due to the price competition and transparency once the exchange starts operating fully.