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Commodity trade in Pakistan

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A commodity exchange is a market where buyers and sellers of commodities can


interact.
Typically these exchanges offer standardised contracts with varying maturities called
futures contracts.

These contracts may be cash settled or physical delivery-backed.To


understand the difference between these two kinds of futures contracts, assume that
party A enters a one-month futures contract for one ton of wheat, with party B.
One month after the contract was entered; the price of a ton of wheat had risen by Rs
200.
If the futures contract were cash settled, party B would pay party A the differential
amount of Rs 200.
In case of a physical delivery contract, party B would deliver one ton of wheat to
party A, as stipulated by the prior agreement.Formerly known as the National
Commodity Exchange Limited; Pakistan Mercantile Exchange (PMEX) is the
countrys first and only online commodity futures exchange.
PMEX was formed in 2002, although it formally began operations in May 2007 with
the launch of its first product, gold futures contract.
This listing was followed by the first gold physical delivery in August of 2007.
Subsequently, more products including futures contracts for rice, palm olien, crude oil
and silver have been added to the list of offerings at the exchange.The demutualised
exchange is jointly owned by six shareholders, including National Bank of Pakistan,
Karachi Stock Exchange, Lahore Stock Exchange, Islamabad Stock Exchange, PakKuwait Investment Company and Zarai Taraqiati Bank.

HYPERLINK

"http://www.agricorner.com/wp-content/uploads/2011/10/PMEX-Commodity-TradePakistan.jpg" Shareholdings of each of these stakeholders are presented in the table


below:The board of directors of the institution includes 13 members, of which 6
represent each of the shareholding institutions, 6 are independent directors appointed
by the Securities and Exchange Commission of Pakistan (SECP), while the chief
executive of PMEX is the thirteenth director.

The functioning of the exchange is regulated by the SECP; while other relevant
legislations pertaining to the PMEX include Commodity Exchange and Futures
Contract Rules 2005 as well as internal regulations.At present, the exchange has 313
members and 120 registered brokers, of whom 42 are currently active.
Since this is a demutualised exchange, membership is open for all applicants.
PMEX offers two kinds of memberships: Universal and Commodity Specific.
Universal membership costs Rs 2.5 million, while the member must also exhibit net
worth of at least Rs 20 million.Universal members can offer all listed products of the
exchange to their clients.
Commodity-specific membership costs Rs 750,000; while a net capital balance of Rs
10 million is required.
The number of active brokers increased by 30, during FY11 as investors interest
has heightened in the wake of surging global prices of commodities.The commodity
boom has also attracted many new investors to the exchange, because of which its
trading volumes have surged in recent months.
In April 2011, PMEX observed record monthly volume of Rs 68 billion, surpassing
the combined volume of the three stock exchanges which tallied Rs 66 billion, during
the same month.
Operating hours at PMEX have recently been increased by 21 hours per day in view
of fast-changing realities of international commodity futures markets facilitating
greater participation of local investors.As a consequence, traded volumes at PMEX
increased by a whopping 671 percent, to Rs 490 billion in FY11 compared to Rs 63
billion in the previous year, while the number of investors at the exchange also grew
by about 245 percent over the same period.What can be traded? At present, multiple
futures contracts are available for gold, silver, crude oil, palm olien, rice and sugar
and KIBOR rates.
Those contracts which are based on international market prices of commodities such
as crude oil are cash-settled while physical delivery is offered on gold contracts and
efforts are underway to offer the same kind of contracts for locally produced
commodities such as rice and sugar.Efforts are currently underway to introduce
futures contracts for cotton and maize.
Over the next five years, PMEX intends to increase its focus on agro-products while
also increasing its reach in agricultural zones of the country.
Under this plan, four offices will be opened during FY12, while approvals will be
sought from the regulator for more offices in the future.The exchange is also

developing linkages for the establishment of an independent warehousing framework


which can be used to store commodities that can then be traded through physical
delivery-backed futures contracts.How does it work? The functions of the exchange
can be broadly classified into five different categories: IT and systems, analytics,
operations, compliance and product research and development.
These departments perform functions ranging from clearing and settlement, to risk
management, surveillance and applications development.There are two methods of
trading on PMEX: direct access to the market, placing orders through brokers.
Investors can use the online trading platform of the exchange to monitor markets in
real-time and this platform also facilitates the placement of orders.
However, in both cases the broker is the obligor to the exchange.As such, it is the
responsibility of the broker to ensure that clients pay the required margins and comply
with all relevant regulations along with monitoring exposure and positions taken by
clients.
Brokers earn commissions on all trades routed through them.It is worth mentioning
here that although PMEX mitigates counter-party risk, there are inherent risks in
trading of commodities and futures contracts by virtue of price volatility.
As such, all investors must exercise caution when assuming positions in this or other
markets, in accordance with their own risk appetite.How does it mitigate risk? When
two parties enter into a contract bilaterally; they are exposed to many risks including
non-payment, difference in quality of delivered goods, etc.
However, when the same futures contract is executed through an exchange such as the
PMEX; the exchange becomes a third-party arbiter between the two parties,
guaranteeing financial settlement of all trades.
As such, the risks involved are significantly mitigated, while contracts are also
standardised and regulated through the exchange.In order to mitigate associated risks,
the exchange has multiple measures in place which monitor activity at different
stages.
Initial margins are collected from investors on each contract entered on the basis of
value-at-risk (VaR).
All positions are marked to market on a daily basis and margin calls are made, where
applicable.
These margins are collected in cash only, on a gross basis so risk from each client is
segregated.

Online bank transfer facilities are catered for the collection of margins, to ensure
quick receipt of funds.In addition to these margins, brokers also have to maintain
minimum deposits with the exchange which can be used to settle any defaults by their
clients.
This deposit, which serves as a second line of defence against default is also
monitored daily and adjusted according to changes in the magnitude of price
fluctuations.
Separate position limits are also enforced at both client and broker levels.The
exchange also monitors the activity of each investor using client IDs so even if one
client operates accounts through multiple brokers, his cumulative positions are
monitored in totality by the exchange.Source: PMEXAll information and data used
are from reliable source(s) and subjected to extensive research after diligent and
reasonable efforts to determine the soundness of the source(s).
====================================
Shareholder
No of
shares (mn) share (%)
====================================
NBP
9
47.4
KSE
3.64
19.2
LSE
2.27
11.9
ISE
2.27
11.9
PKIC
0.91
4.8
ZTBL
0.91
4.8
Total
19
100
====================================
Source:
PMEXAll information and data used are from reliable source(s) and subjected to
extensive research after diligent and reasonable efforts to determine the soundness of
the source(s).
This analysis is not for the benefit of or discredit to any person, scrip or tradable
instrument.
The content(s) of this analysis shall not be construed as an advice or recommendation
to trade.
No relationship of client will be created between Business Recorder and user of this
information.

Professional advice must be taken by the reader before making investment/trading


decisions.
BR disclaims any liability for investment(s) made or liability accrued on basis of this
analysis.
The content(s) including all opinion(s), statement(s) and information are subject to
change without prior notice and/or intimation.
Copyright Business Recorder, 2011

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