This is despite the fact that the exchange has been fully prepared for launch since July 2004 and in the meantime, hoarders and profiteers have successfully engineered one commodity pricing crisis after another.
What gives? For several months now, especially after the March 2005 stock market crisis, the Securities and Exchange Commission of Pakistan seems unable to shake of its cold feet when it comes to futures trading.
The regulatory authority has since reiterated several times that commodities futures trading cannot commence until a Futures Trading Act is framed. They seem to be overlooking two facts. First, if regulation was inadequate, why did the SECP pass the Commodity Exchange and Future Contract Rules which were then approved by the federal government on March 15, 2005?
After all, that legislation took one year to draft and the SECP went through due process, inviting public opinion and then passing the rules onto the federal government.
Second, the stock exchanges are already engaged in futures trading and have been mandated by the SECP to immediately introduce index futures as well. Moreover, in several countries around the world, futures, options and derivatives are considered securities and treated as such in legislation.
Then why is it that here, regulators remain mired in confusion, permitting options under the Securities Act but maintaining that derivatives require a separate piece of legislation?
NCEL’s team of experts has long argued that there is no need for new and elaborate legislation in order to commence derivatives trading. Instead, as in the rest of the world, existing regulation can be slightly amended to cover for this form of trade.
In India, for example, where a thriving commodities futures market now exists, the Contract Act was simply amended and derivatives made part of the Securities Act. Indeed some 85 per cent of jurisdictions use a single piece of legislation to permit trade in derivatives.
Since the appointment of the new SECP chairman in January, several meetings have been held with the officials of the Commodities Exchange and a previous decision from September 2005 was restated requiring that the SECP conducts an analysis to survey weaknesses in NCEL’s system. That’s all very well.
But the SECP still needs to explain why the regulatory debate is now being reopened. Is this an implicit admission that the initial process of drafting the rules was inadequate? If so, the SECP needs to come out and say it and then spell out a time frame and plan for redoing the process.
Or does this simply represent a lack of technical expertise at the capacity-depleted SECP which has caused this excessive delay and loss? The regulator does not seem to have felt accountable for this yet.
Even a cursory study of NCEL’s risk management system suggests that it is far ahead of the still-archaic systems used by the stock exchanges. NCEL plans to conduct pre-trade risk checks and market monitoring and surveillance at the client and not just the broker level.
NCEL is also the sole exchange that has a link with a clearing bank so that deposited funds are automatically transferred to NCEL systems on a real-time basis. It has a disaster recovery site and digitally certified USB keys for secure access. Indeed the SECP itself awarded NCEL the mandate earlier this month to restructure the risk management systems of all the three exchanges, a strong but somewhat contradictory endorsement on the part of the regulator.
Perhaps one cause of the delay in commencing trade is the fear that NCEL’s systems will show up the stock exchanges who remain prone to crises that can and should be prevented by modern risk management practices.
The new expectation is that NCEL’s operations will begin within the next three months. Meantime, the new exchange held hostage to the SECP’s inadequacies faces a range of problems. They are sitting on an investment of Rs 103 million in hardware and software that is still unused for the last 20 months.
More than half their 45 employees have left, largely out of frustration with many returning to their jobs overseas. The exchange also continues to incur the expenses of day-to-day operations without being able to generate sufficient revenue. Finance advisor Salman Shah was requested to intervene but he failed to get things going for NCEL either.
Urgently needed: While delays continue, industrialists, traders, hoarders and profiteers are taking full advantage of an opaque price discovery system. Wheat and sugar crises which have devastated common citizens could well have been avoided if the commodities exchange was up and running.
By listing futures contracts, signals for future prices are efficiently generated and short term imperfections minimized. In India, for example, prices have stabilized since commodities futures trading began and the government’s Food Corporation of India which aims to provide price support for farmers and maintain grain stocks to ensure food security, plans to buy and sell through the commodity exchanges and thereby reduce its annual storage and interest costs which amount to about 40 per cent of their annual food subsidy.
Similarly, the gold market is also clamouring for futures trading since rising gold prices mean they’ve been hit hard by dwindling sales. If gold traders had a hedging instrument available through which they could protect against future price changes, they would not have suffered this quantum of losses.
Besides, the need for a commodities exchange is always paramount in a agriculture-dependent economy since it provides both price risk management and price discovery. It generated price signals of essential commodities into the future, reduces the effect on income uncertainty for farmers, reduces price volatility in essential commodities and helps foster an environment for better agriculture research, investment in warehousing and better access to agriculture credit.
With improved price certainty, farmers would also be in a better position to improve input and production decisions, although this process will require fairly aggressive education and awareness building among the farmer community.
Dubai ahead of the game: In Dubai, these benefits were quickly realized and the Dubai Gold and Commodities Exchange, a new online commodities derivatives exchange began trading in November 2005.
The Dubai exchange was conceived and established much later than NCEL and took just 12 months to go live, similar to how the Indian commodities exchange began. That exchange is doing well and trading of gold futures contracts has already hit 1000 per day.
Probably frustrated by waiting for NCEL to start operations, Pakistani stock brokers and others have acquired membership of DGCX and Dubai-based brokerages have been trying to solicit business from Pakistani clients having identified a gap in the market and the demand here for instruments of hedging. DGCX has a risk management and technological infrastructure that is similar to the one established by NCEL.
However, NCEL has adopted more stringent processes, putting in place pre-trade checks at the client level and an online banking arrangement that is integrated with the trading system.
NCEL has long been prepared to kick off trading with three month gold futures contracts followed by rice contracts and then contracts of cotton seed oil cake, sugar, red chillies and lentils. The 283-member de-mutualized exchanged has been patterned on India’s National Commodity and Derivatives Exchange but risk management practices have been further improved.
A concern does persist about whether NCEL will be able to generate sufficient volumes to become a vibrant futures market. In gold, the exchange expects to generate volumes equivalent to 25 per cent of the gold spot market which imports 50 tons of gold a year. But futures contracts in cotton and financials are likely to generate far greater interest.
The question now is when the SECP will get its act together and authorize the exchange to go live and make an invaluable contribution to the financial markets and the economy.
If indeed the only real hold up is the SECP’s own inadequacies in the shape of lack of technically sound personnel or enough people to process the matter, it is a wonder then that the government has not intervened to push the regulator to get on with it and stem the wasteful losses NCEL has had to bear so far.
After all, Islamabad never seems to have issues with interfering with the independence of the regulator when it comes to complaints by the broker community. If the government refuses to give up intervention in so-called independent regulatory bodies, they may as well start using some of it positively.
<nmangi@yahoo.com>