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What It Has and What It Lacks

“We should all be concerned about the future because we
will have to spend the rest of our lives there”.
~Charles F. Kettering

“Caveat emptor” -- Let the buyer beware

“We are moving from a world in which the big eat the small to
one in which the fast eat the slow”.

Klaus Schwab, 2000

(Founder of the World Economic Forum)
In early proto-capitalism and era of trade, Derivatives first
emerged as a tool in commodity trading. In Pre-Islamic era of
Arab region we see many people locking in commodities at a
certain price, the same people which accepted Islam later. It was
after that it initiated as a useful hedging tool in financial markets
as well. The fundamental mechanism of a derivative contract
remains the same whether the asset happens to be a commodity
or a financial asset. However there are various uniqueness, which
are similar to commodity derivative markets. In the case of
financial derivatives, most of these contracts are cash settled.
Even in the case of physical settlement, financial assets are not
bulky and do not need special facility for storage. Due to the
bulky nature of the underlying assets, physical settlement in
commodity derivatives creates the need for storage. The same
way concept of differing quality of asset does not really exist as
far as financial assets are concerned. While in commodities, the
quality of the asset underlying a contract can vary largely. This
becomes an critical point to be considered.
National Commodity Exchange Limited (NCEL) is the first
technology driven, de-mutualized, on-line commodity futures exchange
in Pakistan. NCEL’s shareholders are National Bank of Pakistan, Karachi
Stock Exchange, Lahore Stock Exchange, Islamabad Stock Exchange,
Pak Kuwait Investment Company (Pvt.) Limited, and Zarai Taraqiati
Bank Ltd and it is regulated by Securities and Exchange Commission of


• Price Distortion • Observable prices

• Wide spreads or one way quote • Narrow spreads and two way quotes

• Lack of storage • State of the art warehousing

• Quality certification & standardization

• Absence of standardization
• Complete risk mitigation
• Counterparty risk

• Impediments in financing • Ease

• Price manipulation

"To provide an opportunity to the farmers to farm for the market"[1]

At present there are 14 commodities being traded at NCEL under
following categories:
NCEL IRRI-6 Weekly Rice Futures Contract


NCEL IRRI-6 Rice Futures Contract

Palm oil
NCEL Palm Olein Futures Contract

NCEL Gold (1 Ounce) Futures Contract
NCEL 100 Ounces Gold Futures Contract
NCEL 100 Tola Gold Futures Contract
NCEL 50 Tola Gold Futures Contract
NCEL 10 Tola Gold Futures Contract
NCEL Kilo Gold Futures Contract
NCEL Mini Gold Futures Contract
NCEL Gold Futures Contract

NCEL Silver (500 Ounces) Futures Contract

Crude oil
NCEL Crude Oil Futures Contract

Interest rates
NCEL 3-Month KIBOR Futures Contract

Karachi Stock Exchange the biggest stakeholder, has provided the
technical support for NCEL. Trading is also facilitated through two other
stock exchanges in the country along with universal access by Web
The automated trading system provide market participants with online
market and price discovery system guaranteeing the best bid and offer
for all market members. 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.

We can never say that Derivatives market totally eliminated the risk in
Commodities because there are certain uncontrollable risks such as
weather, production level and demand during a season, .they can
certainly be minimized. The exchange introduces 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.

The National Commodity Exchange Limited is the only exchange in

Pakistan that provide a centralized and regulated place for commodity
futures to be traded in Pakistan. It intend to grow into a leading
Commodity Exchange not only in the country but also in the region to
present fully automated trading, settlement and risk management
systems at par with international standards.
The exchange deal in the trading of commodities such as gold, rice etc.
Gold was the first commodity to be traded and trading of other
commodities followed in phases.

The establishment of the exchange is the continuation of policy of Free

Trade and Economics Liberalization which is the pre-requisite of WTO.
Thus government Support it to encourage 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. Hence the cash equity of Rs 310
million is used to develop the infrastructure necessary to
accommodate the fully automated trading.

Participants in Commodity Futures

• Importers/Exporters
• Commodity Financers
• Farmers/ Producers
• Consumers/ Industry
• Traders
• Corporate having price risk exposure in commodities

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 also regulate the
handling exportation from and importation of commodities into the
country from its warehouses headqurtered at Karachi and Bin Qasim.

It also aspire to keep up high standards of viable honour and integrity,

to promote and instill principled and ethical practices and just and
equitable values of trade and business, to discourage and suppress
malpractices, to settle and decide points of disputes and violations in
code of conducts.

One of the positive aspects of NCEL is that it co-ordinates with FPCCI

and other local chambers of commerce, trade bodies in order to
regulate the commodity trade.
In General the Commodity prices are less unpredictable than the
stocks and this has been proved in various researches. So it is safer to
invest in commodities for Risk-Averse Investors.
Also the regulatory authorities at NCEL and SECP ensure through
continuous monitoring that the commodity prices are Demand-Supply
Driven and free from exploitation.
On the other hand the investments are subject to market risk and
depend on the individual decision as to which extent he has the ability
to bear the risk. Like any other investment there is risk of loss while
trading in commodity derivatives.


The National Commodity Exchange is a new idea in Pakistan to 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 throygh online website. The foundation of a centralized
and regulated market will attract investment in the futures trading to
offer new areas for investment in commodities.
A case to analyze is that The global oil prices have rouse around 2
years back to 15$/barrel 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 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

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 has changed the way of doing business for the
benefit of the national economy and the growers in particular. 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 much needed
investment both foreign and local into the country. Futures trading in
commodities is better than investment in the stock market as in it is
not static but comprise commodities which are not held physically but
are real.

Although futures hedging in commodities is no solution for price

variation and abrupt changes it does offer an opportunity for hedging
not available previously which can bring stability to some extent.
Commodity trading through futures allows the buyers and sellers a
hedge against price changes that may abruptly affect their business to
make an informed decision to improve the profits or cut the losses.
Thus the growers and the intermediaries would be able to sell the
commodities at any time on their own discretion as and when the
prices suit them.

Without a Regulated Commodity Market Place the whole mechanism of

non-transparent trading in which a commodity changes many hands,
offers no protection to the large segment of growers and producers of
agricultural commodities. It also results in trading where a commodity
varies in quantity, description, quality and price.

The commodity trading with NCEL which is accessible from around the
world through its website would benefit the large agrarian community
which previously were deprived of fair market prices of their products.

In a traditional setting when the bumper crop comes in the market,

prices fell so low that farmers could not repay their loans, despite
abundant production resultantly in the subsequent year not enough
food is produced to feed the population.

Although Pakistan is the biggest grain producer in the region, its

traditional markets are small because of narrow networks of trust
among buyers and sellers. Most farmers trade within 12 kilometers of
their farms and only with people they know.

The National Commodity Exchange Limited provides warehousing, a

reliable payment system, real-time market information, and quality
control. Producers sell directly to the exchange, which assures
payment within 24 hours.
In the past, truck drivers took payment in envelopes filled with cash. It
was never certain if or how much of the money would make it back
into the hands of the seller. Buyers in the traditional system do not
know the quality of what they get unless they open up the sacks and
inspect the contents.
Now in the exchange setting NCEL takes the task of the commodity
evaluation and ensure the quality, so even a far-away buyer can be
confident of what he/she is buying.

Another benefit of Commodity Futures is that there is no 'Time Decay'.

Options suffer from time decay because the closer they come to expiry
the less time there is for the option to come into the money.
Commodity futures do not suffer from this as they are not anticipating
a particular strike price at expiry.


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 lets say the rice buyers and sellers to
trade 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 Agriculture is the backbone of Pakistani
economy and since rice crop is the one of the biggest earner the
futures trading will also result in increased exports.

A farmer may have a field of rice and in order to hedge against the
possibility of rice prices dropping before the harvest he might sell rice
futures. He has locked in the current price, if rice prices fall he makes a
profit from the futures contracts to offset the loss on the actual rice.
On the other hand, a consumer such as rice trader/exporter may buy
rice futures in order to protect against a rise in the cost of rice.

The open market price of individual commodities fluctuates from time

to time within a day. The contracts on can be bought or sold prior to
the delivery date thus helping a cultivator or a broker to off-load a
commodity prior to the delivery date. Thus the original seller, the
hedgers, or the average investor, the speculator, can profit through the
price movements.

Development of a futures market also help the informal and the

unorganized sector to be competitive and transparent for the benefit of
the agriculture in the country where growers continue to moan about
not getting the fair prices for their labour.
According to Mr. Chamdia(The First MD of NCEL) 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.[2]
Thus to summarize NCEL provides following benefits:
• Efficient price discovery protects from seasonal price volatility
and abrupt changes.
• Hedging the price risk associated with futures contracts
• Purchase option on discretion of the buyer as and when needed
rather than large cash purchases and its storage.
• Greater flexibility, certainty and transparency in procuring
commodities would aid bank lending.
• Hedged positions of producers and processors would reduce the
risk of default faced by banks who have advanced them loans.
• Lending for agriculture sector would reduce the food shortage as
more farmers will be able to grow due to increased liquidity
• Provide margin financing to traders in commodities exchanges.



• Ability to profit from huge commodity market which is much
secure than a Stock Exchange.
• Robust, scalable, state-of-art technology deployment.
• Ability to trade in multiple commodities from a single point
• Iif given proper guidance Traders would be able to act as Rural
Advisors and Commodity Specialists which can guide farmers to
grow which crop, which seed to use, which type of fertilizers are
more effective etc.


The need for Futures market is often justified by the fact that
traders/brokers will have some thing to trade, large volumes and
brokerage fees.
The Derivatives market has more of a role to play in the economy.
In Pakistan agriculture has traditionally been an area with some
government intervention. Government intervenes by trying to maintain
buffer stocks, setting support prices for the farmers, and they have
import-export restrictions and a host of other interventions. Many
economists think that we could have major benefits from liberalization
of the agricultural sector in the era of free trade and WTO.
Thus the problem is who will maintain the enough stocks for domestic
requirements, how will we smoothen the price fluctuations, how will
farmers not be at mercy of tomorrow that price will crash when the
bumper crop comes out, how will farmers get signals that in the future
there will be a great need for wheat or rice. In all these aspects the
futures market has a very big role to play.
If we think there will be a shortage of wheat tomorrow, the futures
prices will go up today, and it will carry signals back to the farmer
making sowing decisions today. In this way a system of futures
markets will improve production patterns.
Moreover if a farmer is growing rice and worried that by the time the
harvest comes out prices will go down, then he can sell wheat on the
futures market. He can sell rice at a price, which is fixed today, which
eliminates risk from price fluctuations. These days, agriculture requires
investments -- farmers spend money on fertilizers, high yielding
varieties, high cost of electricity and other charges raised by our
governmentetc. They are worried when making these investments that
by the time the crop comes out prices might have dropped, resulting in
losses. Thus a farmer would like to lock in his future price and not be
exposed to fluctuations in prices.
Futures market will produce their own kind of transition between the
present and the future. If the future price is high and the present price
is low, an arbitrager will buy today and sell in the future. The converse
is also true, thus if the future price is low the arbitrageur will buy in the
futures market. Thus these activities produce their own optimal levels
of stocks, averages prices. They also work very effectively when there
is trade in agricultural commodities; arbitrageurs on the futures market
will use imports and exports to smooth local prices using foreign spot
To summarize in today’s era of Free Trade and Economic Liberalization
commodity futures markets are a part and parcel of a program for
agricultural liberalization. Many Agrarian experts understand the need
of liberalization in the sector. Futures markets are an instrument for
achieving that liberalization.
• For risk-averse investors NCEL provides a good low-risk portfolio
• There is Less volatility in futures contract as compared to
equities markets .
• Better risk-adjusted returns.
• For Mutual Funds NCEL provides a good hedge against any
bearish trend in equities as there is little relationship with equity
• High corelation with changes in inflation.

The NCEL System

A NCEL transaction has following components trading, clearing and

settlement. A brief overview of how transactions happen at NCEL.

The trading system on the NCEL provides a fully computerized system
for trading futures on commodities on a nationwide basis as well as
online monitoring and surveillance mechanism. While taking order it
inquire about Its commodity, its price, time and quantity.The exchange
specifies the unit of trading and the delivery unit for futures contracts
on various commodities. The exchange notifies the regular lot size and
tick size for each of the contracts traded from time to time. If a buy
order is given the exchange will try to find a sell order with same
specification. When the orders are matched, members are informed of
the deliverable/ receivable positions or the unmatched position if order
is not successful.
Futures contracts have two types of settlements, the continuous
settlement which happens on a continuous basis at the end of each
day, and the final settlement which happens on the last trading day of
the futures contract when the future contract expires. All positions for
settlement created during the day or closed out during the day are
settled at market to market price or the final settlement price at the
close of trading hours on a day.
On the date of expiry, the final settlement price is the spot price on the
expiry day. The responsibility of settlement is on broker. A professional
clearing member is responsible for settling all the participants’ trades,
which he has confirmed to the exchange.
While on Deliverable Contracts on the expiry date of a futures contract,
members submit delivery information through delivery request window
on the trader workstations provided by NCEL for all open positions .
NCEL on recieving such information matches the information and turn
up at delivery position for a member for a commodity. The seller
intending to make delivery takes the commodities to the designated
warehouse of NCEL .
In order to hedge against the uncertainty of the monetary policy of the
State Bank Of Pakistan, specially Bank Rate, which is dictated by IMF
rather than set by SBP these days, NCEL introduced much awaited
KIBOR Future.
Interest rate risk is one of the risk which is inherent in a Capitalist
Economy, which no one can evade in the economy.
Whether a business is exposed to Equity market bearish risk, Currency
depreciation risk, Commodity fluctuation risk or not, it will always be
exposed to Interest rate risk in the economy.
Karachi Inter-Bank Offer Rate (Kibor) represents the rate at which
banks are willing to lend funds to each other. This benchmark rate is
an important reference point as most lending transactions are linked to
this rate.
In addition to lending to consumers many Financing Instruments are
linked with KIBOR as they use “KIBOR+” formula for rate fixation.

Thus every Financial institute has a need to hedge against adverse

moves in the KIBOR specially those involved in Lending and Borrowing.
Thus NCEL provides equal access to all, companies and individuals also
have an opportunity to come straight to the market to hedge their

The Futures Trading in KIBOR has main benefit to the financial

community that they get tradable yield curve which provides
information about the Future path of the KIBOR thus they can
anticipate the change early and can take decision in a very wise way
that wasn’t possible before.
It is also beneficent for end consumers as their loans are issued at
floating rate that is “KIBOR+” approach thus they are directly exposed
to any movement in KIBORR.
One case to analyse is that of Textile and Cement sector companies
which get loans at floating rate when KIBOR was low, for their
expansion purposes. When the inflation rises the State Bank Of
Pakistan raises the Bank Rate thus KBOR Rises which resultantly
increased their Cost of Debt

Thus the Information about anticipated KIBOR movement allows Banks

and other financial institutions to develop, price, sell and hedge a
variety of financing and saving products customized to the needs of
their customers. Customers benefit from a range of better priced
products suited to their needs and banks benefit by better Risk
Management which leads to lower level of reserve requirements.

In early days Gold was used as monetary unit rather than a
commodity. Eeven in our time it is primarily a monetary asset, and
partly a commodity. People buy gold for storage of Value purposes
rather than using it . The largest buyers of Gold are considered to be
Central Banks, IMF,WB, Investment companies and large jewellery
manufacturers. Thus we can assume that gold is primarily a monetary
In Pakistan the annual Import of Gold is estimated to be 50 Tones. The
Investment in Gold is considered to be risk less and inflation protected
and a good source for Investment Diversification.It is even considered
better in risk as compared to T-bills as they have counter party Risk.
Recently KASB Mutual Fund has launched its Gold-Protected Mutual
Fund in which 35% investment is in Gold.
Gold as a commodity is special in itself because an investment in it is
Timeless . It is an effective diversifier better than cash for an
investment because it is highly liquid and responds when it is needed
most. The currency/Cash do depreciate considerably with time with
fluctuations in Interest, Inflation but Gold is not directly hit byit.
The importance of Gold as Effective diversification cannot be negated
specially during recessionary periods during which Stock markets are
marred with Slump and bearish trend. Other methods of Investment
portfolio diversification also fail when they are most needed, that is
during financial instability because of correlation among economic
indicators and volatility. Thus Gold Provides a safe hedge

In recent times we have seen that Gold prices have changed and have
gone to record prices that is Rs.39000/Tola.
Gold is considered to be a symbol of pride in our traditional culture and
we have seen a considerable consumption of it mainly in Jewelry
The presence of Gold Futures have provided a necessary hedge
against rising prices to the Jewelry industry and Consumers as well.
The Investment Firms can also benefit from Gold Prices by locking in
Gold Today thus protecting themselves from Inflationary Pressure,
Interest Rate Fluctuation and Currency Depreciation.

NCEL – What It Lacks and What Need To Be Done

1- Lack Of Market Information:-

The NCEL on its only official website claims information being
delivered all over the country. But it failed to inform us that how it is
disseminating information in the Rural and Sub-urban Areas where the
Internet and Telecom Penetration rate is very low as compared to
Large Cities. The Small Farmers even don’t know how to write and read
in English let alone getting information from the website. The claim
that market information is transmitted all over the country is,
therefore, misleading and false.

2- Lack of Awareness Programs

The Futures market in Pakistan is Under Developed in a sense that
Commodity traders/Producers/Farmers don’t have the idea about
Futures Market and how it Operates.
They stick to old way of trading where a commodity changes 4 or 5
hands before reaching end user resulting in price
distortion/hoarding/discrimination etc. by brokers hence a wretched
Another factor to note is the low literacy rate specially in rural areas
from where the majority of commodities come. The producer don’t feel
the need of literacy let alone the need of IT infrastructure employed by
NCEL should held awareness programs through out the country in rural
and urban areas in order to create awareness.
Secondly it should establish support centres in Main Rural hubs for
Support/Advice to farmers/Producers.

3- Lack of Option Hedging tool in NCEL:-

Futures’ trading is a good way for hedging against price fluctuations

but possibly not the best way.
There is another derivative tool that is Options which is not being
offered at NCEL. In Futures a farmer can lock in the commodity against
the fall in prices but he cannot benefit from the rise in the prices thus
he remains elusive to gain in market prices.
Similarly, a consumer can lock in commodity at a certain price to
protect from raise in prices but he possibly cannot gain from reduction
in prices.
Thus there is a need of an Option market in NCEL as it will benefit the
Farmers/Growers in Agrarian economy.

4- Absence of Commodities Having Hoarding/Black Marketing

Still NCEL is void of those commodities which are being Black Marketed
and are under the influence of Hoarders thus driving their prices at
artificial Levels.
The case being discussed is that of SUGAR and WHEAT CRISIS which
the nation have experienced recently.
If the Futures market was available for those commodities the prices
would have been at stable level as the path of future prices would have
been known to the producers/growers and Consumers/Industry. Thus
an equilibrium price would have been set instead of artificial price
5- No Currency Futures:-
It is a very deplorable and sorry affair of state that there is no currency
Derivatives market in Pakistan where Domestic currency has
depreciated like a fruit get rotten.
The effect of currency depreciation is hefty on the economy as every
sphere of economy has taken a hit by it. The major chunk of Inflation
has come from Rupee depreciation against Uncle Sam’s Dollar. The
raw material imported from abroad used in industry got expensive due
to Rupee fall which resulted in cost of end product high to the
consumer thus Inflation.

Another case is that of Pakistan Government which has foreign loans

amounting to be more than $50 Billion. A increase of 1 rupee from a
parity of $1:Rs.60 cause rise in External loans amounting to Rs.46
Billion and at a parity of $1:Rs80 the Government of Pakistan has
accumulated around Rs.900 Billion on Foreign loans just because of
Currency Depreciation.

Thus a Futures market in Currency is Imperatives of NCEL so that

future direction of Currencies can be established and to some extent
This will specially help Importers, Exporters and Government as well.