Less knowledge can be dangerous

With the market at large unaware about characteristics of cotton futures contracts and functions and scope of commodity futures exchanges, the Securities and Exchange Commission of Pakistan (SECP) has drawn huge criticism for allowing cotton futures trading on Pakistan Mercantile Exchange (PMEX).
The use of the word cash-settled to describe the characteristic of the instrument has kindled strong negative market reaction, with cotton growers to textile manufacturers terming this instrument "highly risky".
Indisputably, definition of cash-settled derivate instruments and the global commodity markets painful experience with cash-settled contracts suggest that reservations of people linked to local cotton supply chain are justified since the absence of physical trading would distort the local cotton supply and demand dynamics by inviting more opportunists and investors.
But, in this case, their qualms are largely unfounded as the market is ignoring the very important point that the cotton futures contract being offered by PMEX is linked to Cotton No. 2 Futures contract on Intercontinental Exchange (ICE) and would not use local cotton prices as a reference price.
IntercontinentalExchange operates leading regulated exchanges, which trade futures and over-the-counter contracts as well as derivative financial products.
The contracts price quotation would be in dollar term and the daily cash settlement amount shall be the days mark-to-market profit or loss amount in rupees based on the Daily Settlement Price of the PMEX International Cotton futures contract converted at the $/rupee exchange rate as determined and notified by the exchange, according to contract specification provided by PMEX.
Besides, SECP has also drawn criticism from cotton traders for not approving the sale of standardised cotton hedging instruments on the Karachi Cotton Exchange - the largest cotton trading exchange in Pakistan.
Their response is based on the fact that the KCE has strong coordination with the cotton supply chain stakeholders as well as experience in handling hedging instruments, stressing that the cotton hedging facility was available in Karachi till the government suspended this facility in mid 1970s.
However, in this case, the market is again missing out the very important legal clause that exchange traded derivates instruments, such as futures, can only be traded on registered future commodity exchanges, as explicitly mentioned in the Securities and Exchange Ordinance, 1969.
PMEX was given approval since its the only registered commodity futures exchange in the country, which provides authorised trading platform for futures contracts.
Moreover, the hedging facility available to cotton sellers and buyers till the mid-1970s was forward contact, which is a non-standardised contract and cannot be traded on exchanges.
With rice, oil and gold futures contract available on the exchange, addition of the cotton futures contract is a welcoming sign. Moreover, the futures contract linked with international prices would provide hedging benefit directly to both cotton exporters and importers.