Cotton and its products comprise 65% of the total exports of Pakistan


By Akbarali Hashwani
Chairman, KCA

May 19 - 25, 2003




Cotton futures hedge trading was carried-on in the Karachi Cotton Association (KCA) from 1934 to 1975-1976, it was suspended due to the nationalization of the cotton trade by Pakistan government. In letter dated 29 April 2002, the Ministry of Commerce, Government of Pakistan constituted a committee for cotton hedge trading in Pakistan. This committee comprised of representatives of cotton growers, ginners, State Bank of Pakistan, Securities & Exchange Commission of Pakistan (SECP), ADBP, APTMA, and KCA.

After thorough discussion, the Committee's view was that if the government permits hedge trading in cotton, it should be managed by KCA, which had the requisite experience, expertise, trading hall, manpower and brokers. On June 21, 2002, the KCA submitted to the Minister of Commerce the report of the committee on Cotton Hedge Trading in Pakistan.

You are aware that cotton and its products comprise 65% of the total exports of Pakistan. Also that the total production of cotton in Pakistan is not sufficient to meet the total requirement of the cotton textile mills and the cotton and textile trade in Pakistan. Our proposal was, therefore, carefully prepared to prevent "Cornering" and all other aspect for smooth operation of the market.

The SECP did not participate in the deliberations of the Committee because as stated by them, "it regulates matters relating to listed securities." It further stated that if the proposal relates to the formation of a forward or spot market in cotton, then it would fall outside the purview of the SECP. However, if the Committee is working on securities relating to future contracts in cotton, then the matter would require the specific approval of SECP, who further stated that "future contracts based on commodities are derivative securities".



According to the DERIVATIVES DICTIONARY, a derivative product is a financial contract whose value depends on a risk factor, such as

The price of a bond, commodity, currency, share, etc.
A yield or rate of interest.
An index of prices or yields.
Weather data, such as inches of rainful or heating-degree-days,
Insurance data, such as claims paid for a disastrous earthquake or flood, etc.
Also known as "derivative", for short.

The proposal made by the KCA is not a speculative contract based on the price of cotton but is a cotton hedge forward contract to enable all stakeholders to trade or export cotton and its products by making Forward Cotton Hedge Purchase or Sale Contracts.

In this connection, I give below relevant extracts from an article written by Mr. Umar Latif in "The News on Monday, 6 January 2003".

"On limited inspiration, intertwined with unlimited support and promotion extended by the Securities and Exchange Commission of Pakistan (SECP) and to begin with, the Karachi Stock Exchange Limited has given 'birth' to a subsidiary company, named National Commodities Exchange Limited (NCEL), The managing director of the KSE bas been appointed also MD of the NCEL.

There is a whole world of difference, to put proverbially, between stock which refer to shares of public/quoted/listed corporate entities and commodities produced in farms. The corporate entities, shares of which are traded in prescribed lots, known as stock, consist of trading, manufacturing, processing enterprises and others of providing services including financial.

These enterprises need funds larger than their sponsors can contribute. So, they offer part of equity to the public. Those having surplus funds invest in shares of the companies and share in incomes to be generated by their business activities. Thus, besides the sponsors collecting required funds, idle funds with those not having acumen of floating their own business, get a place to put money and reap benefits. Assets created by the investments are rendered 'liquid' in form of ownership share, evidenced by certificates issued by the companies, which are traded on the stock markets. This facilitates change in ownership interest without hassle. This underlines need and gives justification to existence of stock exchanges, known as 'capital' markets, providing a place for change of hands holding equity interest.

What about the 'future contracts' markets? Do they similarly deal in stock of commodities specified? This implies a lot of difference between the two. 'Future' contracts are meant for commodities. Commodities have, besides national, wider international markets. A country cannot produce all the commodities its people consume. This has rendered trading in commodities a complex global phenomenon.



Providing stock brokers an option of trading in 'future contracts' of stocks, by opening up 'forward counter', consisting of large sized capital and floating stocks companies was in itself an objectionable act on the part of the SECP. In shares, forward trading and future contracts bear no justification. Stocks are not commodities, that hedge of them would be a necessity. It is merely making room for speculative tendency.

Come back to the core issue of: 'is it appropriate to make stock markets simultaneously commodities markets dealings in 'future contracts'? Future contracts are meant specifically for commodities needed by people for consumption. At all times and places, their production tends to be uncertain, due to several natural factors, such as climate, drought, certain unexpected natural and environmental changes. Supplies and demands for commodities have to be managed in good order, so as to avoid undue bullish price spurts as well as drops on bearish beatings. Producers and consumers have to be protected from uncertain price trends, so as to serve both the ends well. The art of doing so is in organizing future contracts, taking place through out the year irrespective of short span of seasonal arrivals. Most of the consumers and producers are accustomed with the actual purchase and sale of commodities in certain lots.

But to manage the entire volume well and round the year, though commodities arrival time would be of three to four months, the commodities tend to be subject to 'something more mysterious i.e. purchase and sale in bits of paper'. These bits of paper are known as 'commodities future' contracts that brokers deal on behalf of their principals. Often the brokers turn out to be jobbers, having experience to benefit from others expertise, later acquired by major players of the markets and so often their being producers and consumers of such commodities. 'Future contracts' trading in commodities serve as a safeguard to both producers and consumers interests. The art of balancing act in prices movement, avoiding contrasting spurts, is known as 'hedge'. It is also known as arbitrage overcoming distances of commodities supply sources in giving stable price trend. Prices move at a steady pace and by informed decision.

Specialisation Trading in commodities, like cotton, sugar, oils, rice, jute, wheat etc. is now a global phenomenon. Major exchanges for them exist in main trade centres, like London, New York, Tokyo, Paris etc. Having identical set up in Pakistan for key commodities is as much imperative as elsewhere. Working in the given network demands specialisation. For the purpose, specialized institutions need to be created and promoted. These were here in Pakistan nearly three decades ago, prior to the 'speculative' trading banned during the 1970's. The SECP ought to have exercised care and restraint in giving permission to stock exchange take a lead in creating 'NECL' and begin future contracts in commodities."

With global trading under the auspices of WTO fast approaching; in order to protect & improve our cotton products 65% share in the export economy of Pakistan, it is essential that the government immediately permit the opening of KCA Cotton Hedge Market.



Regarding "Derivatives", I refer to an interesting article, which appeared in the US magazine "FORTUNE" dated March 17, 2003. Mr. Warren Buffett is the doyen of the New York Stock Exchange and has successfully operated there for more than 60 years. He has termed "DERIVATIVES" as financial weapons of mass destruction.