Multi Commodity Exchange of India (MCX) – forays into the cotton futures market

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2010

Multi Commodity Exchange of India Ltd (MCX), India’s largest electronic commodity futures exchange, has broken the grounds on the Indian cotton futures market. MCX launched its comprehensive service for the cotton fraternity in the presence of industry stalwarts, on the morning of October 3rd. The risk management tools, one of the points in the carry forward business being offered by MCX, was a critical necessity for the health of the cotton economy, more so considering the volatile conditions prevalent last year.

The cotton economy is estimated to be at Rs 80,000 crores. According to industry sources, last year the total loss estimated – in the rise and fall of cotton in terms of value – was Rs 18,000 crores. We met up with Arun Sekhsaria, MD, DD Cotton and prime mover of this initiative. He said, “The Indian cotton industry has no credible risk management tool. Last season’s volatility not only affected the entire textile value chain, but also created a huge trust deficit amongst the stakeholders.” He felt that the MCX type cotton futures contract will balance things out and bring in a sense of stability. He further added that entry and exit (liquidity) would be easy on the MCX platform.

Initially, the exchange is offering three futures trading contracts due for delivery in October, December and January. Trading for futures contracts is allowed in multiples of 25 bales of 170 kg each, based on ex-warehouse Rajkot, Gujarat price, exclusive of taxes, with Rajkot being the main delivery centre. MCX further informed that the delivery of commodity is obligatory for cotton contracts and physical delivery is allowed in multiples of 100 bales. An individual trader is allowed to trade at the most 50,000 bales on the MCX platform, the exchange informed. MCX has a network of 2,40,000 terminals across India.

In terms of implementation, the contracts, once entered into by the stakeholders in the value chain, are first validated and notified by FMC after which MCX lifts the contract. There are certain parameters that have to be met. Firstly, the system works on the principle of compulsory delivery contract. Besides Rajkot, there are warehouses across the cotton growing regions. The warehouse operations are taken care of by MCX’s sister concern, National Bulk Handling Corporation (NBHC). Secondly, NBHC does the grading and quality testing of the cotton.

Benefit to Ginner?

When the sellers deliver cotton at MCX, their timely payment is guaranteed by the Exchange. The sellers can sell their estimated produce in advance at MCX and lock their price; if the prices fall, they are not bothered, because they get profit from the futures market. The sellers have both options – either to deliver at MCX at contract maturity or to sell their produce in local physical market and square off corresponding position in futures market. If the price falls, the loss in physical market is compensated by profits in futures market.

Benefit to Buyers?

Buyers can buy their requirements of the year in a futures contract by paying a margin of only 5 % and lock their price for the entire year. They can keep on procuring cotton in physical market round the year and square off corresponding position in futures. In that case, even if the cotton price goes up, they do not incur any loss, because they get profit from futures market, which offsets their increased cost of procurement.

Speculation fears?

According to MCX’s Sumesh Parasrampuria, Director, Business Development, “I would urge the industry to focus on hedging. Speculation is bound to happen as it does in other exchanges. In such a scenario, we have put in place a 3% circuit breaker followed by a 15 minute cooling off period. The market will then reopen at 1% higher/lower value.”

Historical background of cotton futures contract

Cotton futures and risk management has been in play since way back in 1890s, started by a few cotton associations. Trading was conducted on a non-technological outcry basis, both by EICA and even New York futures. Volatility has been a constant since the 1914s to date, notwithstanding the various tools then to control it. Way back in 1918 the government appointed a committee that concluded that there was a need to have a permanent ‘cotton contract control board’ to organize, mobilise and regulate cotton contracts – be it spot, forward or futures. It is reported in some sections of the industry that eventually EICA was brought in for this particular purpose, as a result of this committee report in 1922.

After many efforts at various exchanges, including Surendranagar exchange who were doing well in kapas (seed cotton), there is still a strong need to risk manage transactions in cotton and thereby get proper price discovery. NCDEX has a kapas (lint cotton) contract, which according to sources, is leveraged by MNCs who have established themselves here and are profitably using this exchange to co-ordinate with their own risk management tools available out of India.

China with all its status policy, successfully leverages its bourses for spot/forward/futures contract and indexation of cotton and other commodities in the most advanced and advantageous manner. This also helps them to have advantage on its raw material input management, thus making its textile industry globally competitive.

How will the MCX futures contract fare?

In the face of the historical background to cotton contracts, MCX has its task cut out. Based on MCX’s presentations at a recent road show in Mumbai, all looks good. But one wonders, where is the hitch? Sumesh has been candid enough to admit that not all good things are perfect. He added; “If there is a hitch, we will work it out with the industry stakeholders. We will resolve it. MCX’s daily trading volume is approx 1 lakh cores per day. We are currently doing 50 lakh trades a day. We target to increase this to 10 million trades per day.” There is no denying that there are challenges, as was obvious from the volley of questions that erupted from the delegates at the Mumbai roadshow. But Sumesh remains unfazed by the challenges. He signed of by saying, “We want ‘MCX Cotton’ to be the benchmark for cotton futures, just like the famed ‘MCX Gold.”

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