National Commodity Exchange Limited (NCEL)
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Transcript of National Commodity Exchange Limited (NCEL)
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Introducing NCEL
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Derivatives
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Derivatives Introduced in 1972
Doubling every 3 years Extremely low failure rate even if comparedto bank lending
Derivatives are termed as new technology Common analogy aircrafts versus cars
Rates of accident per kilometer areextremely low as compared to road travel Trillions of $s are traded daily
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SIZE, as a percentage of US GDP (2004)
Derivatives, OutstandingTrillion US$, notional principal (as percent of U.S. GDP)
$272.86(2340%)
$115.24(988%)
Total
$52.80 (453%)$31.06 (266%)Exchange Traded$220.06 (1887%)$84.18* (722%)OTC Derivatives
GLOBALUS
* US commercial banks only, broker-dealers and others not reporting
Global 23 times the US GDP
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Derivatives & InfrastructureExchange-Traded Derivatives Products: Fixed Income
Foreign Exchange Equity Commodity
Risk Management: Analytics for quantifying risk Risk based margining
Clearing & Settlement: Novation & CCP Guaranteed performance of contracts
100% Trading of credit risk free contracts
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Financials vs. Non Financials 2005
92%
8%Financials
Non Financials
9.9 billion contracts traded in 2005
Financials: 9.1 billion
Non-financials: 0.8 billion
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Global Financials Breakdown 2005
Equity
Indicies44%
InterestRates28%
IndividualEquities
26%
Currency2%
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Global Agricultural, Metal and Energies Breakdown2005
Agricultural44%
Energies36%
Metals20%
Other0%
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Global Commodity Exchanges
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Growth of Commodity Exchanges Three new commodity exchanges in India - 2004
NCDEX is the sixth largest in the world within 2 years ofits operations
MCX to launch cotton yarn contract Two commodity exchanges in Iran and third will be
opening in 2006 Dubai Gold and Commodity Exchange launched in
November 2005 To launch cotton and rice futures in Q3 2006
Dubai Mercantile Exchange being launched in Q32006 Crude Oil, Oil Products and Metals
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1.850.24
0.50
7.758.94
11.83
13.97
16.49
0.06 0.170.72 1.67 2.13
3.514.31
5.29
0m
2m
4m
6m
8m
10m
12m
14m
16m
18m
Q1 04 Q2 04 Q3 04 Q4 04 Q1 05 Q2 05 Q3 05 Q4 05
N u m
b e r o
f f u t u r e s c o n
t r a c
t sNCDEX
MCX
Growth of India's Commodity Exchanges
Source: Exchange data; projections made on the basis of compound quarterlygrowth rates during period Q1 2004 to Q2 2005
CQGR > 120%
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Role of a Futures Exchange Futures Exchange: A regulated and an orderly marketplace where buyers
and sellers express their collective future expectations
Guarantees performance of contracts
Disseminates prices Provides liquidity and depth through centralization
Educates Investors
Exchange is only a thermometer of the pricemovements and is not responsible for the pricemovements
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Participants Symmetric Risk Natural Longs
Who produce (issuers)
Natural shorts Who process or consume (investors)
Speculators Who provide depth and efficient price
discovery
Arbitrageurs Who provide stability by capitalizing on
mispricing between the two markets
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Spot and Futures Markets Two distinct and separate markets
Spot Market Futures Market
The two markets interact to provideprice signals
The linkage between the two markets
provides price stability The existence of a futures market
stabilizes todays prices
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NCEL Vision/Mission
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Vision/MissionFROM Price distortions
Wide spreads or one wayquotes
Lack of storage
Absence ofstandardization Counterparty risk Impediments in financing Price manipulation
TO Observable prices
Narrow spreads and two wayquotes
State of the art warehousing
Quality certification &standardization Complete risk mitigation Ease in financing Price dissemination
To provide an opportunity to the farmers tofarm for the market
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Wheat Price Comparison between Major &
Minor Pakistani Markets(For Four Years)
700
800
900
1000
1100
1200
1300
1400
O c t
D e c
F e b
A p r
J u n
A u g
O c t
D e c
F e b
A p r
J u n
A u g
O c t
D e c
F e b
A p r
J u n
A u g
O c t
D e c
F e b
A p r
R u p e e s
/ 1 0 0 K g
Source: Federal Bureau of Statistics & Agri. Marketing Deptt.
Red = Average of Three Major Markets
Yellow = Average of 9 minor MarketsSowing
Harvest
Harvest
2002-03 2003-04 2004-05 2005-06
Sowing
SowingSowing
Harvest
Harvest
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NCEL Business Model
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Basis of NCELs Business Model What are the ills in our market?
Benami accounts Only, broker level surveillance Very narrow base
High volatility due to excessive leverage Value based margining Broker capital adequacy based on solvency
criteria Check is in the mail syndrome Misuse of collateral
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NCEL Highlights First partially demutualized exchange First all-electronic exchange of Pakistan
First to introduce client level identification
First to provide complete segregation between
broker/client and client/clients First to introduce risk based gross margining
First to integrate online banking with trading
First to undertake client level surveillance
Recent happenings highlights the strengths of
NCELs business model
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Business Drivers Implications
IntellectualCapital
Technology
Regulations
Markets
EnsuringCompliance
ControllingCosts
ManagingRisks
Operations
Key challenges for NCEL is to balance national priorities,reducing risks while improving processes andcontrolling costs
MarketParticipants
A cost effectivesolution ofexceptional
quality
NCEL Business Model
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Intellectual Capital Highly educated and experienced in: Developing and managing high speed IT systems
Derivatives trading & portfolio management
Foreign exchange & money markets
Commercial & investment banking
Compliance
Process improvement & process management
Analytics & risk management Agriculture & commodity financing
Experience of international markets where best practices
are the norm
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Core Components of NCELIT & SYSTEMS Trading Systems Connectivity and networks Database & Disaster Recovery Application development
ANALYTICS Risk Management Research Real-time Analysis Software Specifications
OPERATIONS
Clearing and Settlement Margining and Accounting On-line Banking Delivery
COMPLIANCE
Member Services Surveillance and Monitoring Discipline and Enforcement Process Management
PRODUCT RESEARCH & DEVELOPMENT Contract Development Specifications and Testing
Logistics and Spot Market Practices
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NCEL Technology
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NCEL Trading SystemTrade Capture
Pre-Trade RiskManagement
Mark to
Market
Position
Update
MarketMonitoring
Risk
Mgmt
Banking &Settlement
CollateralMgmt
N CEL TradingPlatform
N CEL Broker
Trader A
Trader B
Assigned
Deal
A & B Clients ofNCEL Broker
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NCEL Trading Terminal -- orders are born here
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NCEL Operations
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NCEL Advantage NCEL able to start from the point other leadingexchanges have reached
Not copycat. Each borrowed technique andmethod is fully re-engineered to suit localmarket
Established exchanges realise need forreforms but adapt slowly over time given theirsize and history
NCEL can leap-frog straight to the future usingtried and tested methodologies from aroundthe world but adapted to local conditions
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NCEL Operations v Rest of WorldNCEL Online, Electronic Trading
up to client level with UIDfor all Client has direct access to
the market with pre-tradechecks
Margining for each andevery account at
Exchange level Monitoring up to clientlevel
Margins in cash only
International Practice Physical and Electronic
Brokers provide onlineaccess All orders routed through
brokers Post-trade margining Members responsible for
margining clients
Market-wide & broker levelsurveillance with clientlevel reporting
Securities are acceptable
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Completely Segregated Accounts
NCEL
Member111-000-000
House
111-000-1000
Client 1111-000-1001
Client 2111-000-1002
Client 3111-000-1003
Client 4111-000-1004
NCEL LEDGER Online Clearing Bank
Daily Account
Swipes
Member111-000-0000
House111-000-1000
Client 1
111-000-1001
Client 2111-000-1002
Client 3111-000-1003
Client 4111-000-1004
Initial & Variation
Margins andClearingDeposits
Cli t 1 Cli t 2 Cli t 3
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Multan Faislabad Muree
Quetta
Client 1 0891-5660 10,000Client 2 0891-5661 15,000Client 3 0891-5662 40,000Client 4 0891-5663 5,000
Broker inPeshawar
Client 1 Client 2 Client 3
Client 4
Online Clearing Bank Accounts
Transfer Client Funds to Exchange
NCEL0791-4830
70,000
Online Bank
Transfer
Online BankTransfer
Online BankTransfer
Online BankTransfer
Symmetric Participation
Natural Longs
Natural Shorts
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Pre-Trade Check for Members & Clients
Member/ClientJ-Trader
ElectronicBrokerBuy/Sell
Order
If SODNLV>Order Margin
Required
SARA
Matching Engine
Yes
NoSystem
Back Office
MCB
SODNLV
Updates
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Daily Settlement All positions marked-to-market daily
P&L of positions in real-time Margin calls generated at end of today
Settlement of margin calls latest by 8.00 PM Trading matches fund settlement
Margins, price limits, and clearing andposition limits ensure that few tradesprogress to the stage of default
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Analytics&
Risk Management
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Risks inClearing andSettlement
Slice N Dice Approach to Risk Management
Credit Risk/
ResidualRisk
Market Risk
CounterpartyRisk
Third PartyCredit Risk
OperationalRisk
LiquidityRisk
SettlementRisk
ConcentrationRisk
VolatilityRisk
Margins (99%)
Clearing Funds tomitigate extreme
events (1%)
Legal Risk
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Value at Risk - An Example Lets use a 5%
probability and a one-day holding period VaR is the one day
loss that will beexceeded only 5% ofthe time
Its the tail of the returndistribution In the example, the
VaR is about Rs60,000
Return Distribution
VaR
( 1 0 0
, 0 0 0 ) 0
1 0 0 , 0
0 0
Portfolio Gains/Losses
P r o b a b i l i t y
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0
10
20
30
40
50
60
T r a d i n
g B e g i n s
S p o t M o
n t h
D e l i v
e r y M o
n t h
Risk Management Example(illustration only)
Settlement Price
Lower Price
Limit
Upper PriceLimit
Spot MonthMargin
VariableMargin
Initial Margin
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Default Protection: Segregation ofParticipant Risk
ClearingParticipants
ClearingParticipantsMarket
ParticipantsMarket
Participants
Prop
Prop
Prop
SGF
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Controlling Excessive Speculation Position limits
Market wide Broker level Client level
Volatility based variable margining Online and real-time client level surveillance
Regulations allow forced reduction ofposition limits if prudential concerns Close-out if breach of Regulations
Reduced in delivery month
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Contract Design
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Contract Choice and Design First Principle: Futures contract should
mirror or improve upon the imperfections
of the spot market Four out of Five new futures contracts fail
and are de-listed within the first five yearsof trading
Two possible reasons: Lack of demand for the contract itself Poor contract design
Of course these two reasons are related toone another
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Product Development Futures and hybrid contracts specifications
which are ready for listing: Gold, Sugar, Rice, Cotton Seed Oilcake, Wheatand Cotton Yarn NCEL 30 stock, NCEL Bankdex, NCEL
Cemdex and NCEL Enerdex indices 3 and 6 months KIBOR Futures C-TFCs (inter-bank repo market)
Developing steel and cement price indicesfor the hedging needs of the constructionindustry with NESPAK
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NCEL & Agriculture
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Benefits of a Commodity Exchange Reduces price volatility
Reveals monopoly mark-up
Generates signals of future prices, today
Converts unregulated market into a regulated market
Empowers state-owned organizations and policymakers to make informed decisions
Improves input/production decisions, if less priceuncertainty, thus improving quality and yield
Vehicle for transmission of the trickle down effect
NCEL H b & S k
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NCEL Hub & Spokes
Producers(Farmers/
Middlemen)NCELAn Electronic
Exchange
Consumers(Retail/
Institutional)
Clearing Banks
Warehousing
QualityCertification
Agencies
Transporters/Logistic Support
Agencies
Traders(Investors)
Arbitrageurs/Client)
Hedger(Exporters/
Millers/Industry)
Global CommoditiesMarket
Spot & Futures M arkets
MCB BankUTI InternationalA US Company
Market Participants
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Sugar Price Comparison
30
35
40
45
50
55
60
65
70
7 / 1 / 2 0 0 5
7 / 1 5 / 2 0 0 5
7 / 2 9 / 2 0 0 5
8 / 1 2 / 2 0 0 5
8 / 2 6 / 2 0 0 5
9 / 9 / 2 0 0 5
9 / 2 3 / 2 0 0 5
1 0 / 7 / 2 0 0 5
1 0 / 2 1 / 2 0 0 5
1 1 / 4 / 2 0 0 5
1 1 / 1 8 / 2 0 0 5
1 2 / 2 / 2 0 0 5
1 2 / 1 6 / 2 0 0 5
1 2 / 3 0 / 2 0 0 5
1 / 1 3 / 2 0 0 6
1 / 2 7 / 2 0 0 6
2 / 1 0 / 2 0 0 6
2 / 2 4 / 2 0 0 6
3 / 1 0 / 2 0 0 6
3 / 2 4 / 2 0 0 6
U S $ / 1 0 0 K g
Pak NCDEX NYBOT
Price Stabilization Using Futures (Good Harvest)
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Fall in Futures Price
Reduced incentive to hold excessstock
Fall in spot price
Increased Supply meets increased
demand
Demand increases with reduction inspot prices
Sale of spot stocks
Sale of Futures via Exchange
g ( )If a good harvest
is expected
PriceStabilizationtakes place
Price Stabilization Using Futures ( Bad Harvest)
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Rise in Futures Price
Increased incentive to hold excessstock
Rise in spot price
Reduced demand meets reduced
supply
Demand Decreases with increase inspot prices
Purchase of spot stocks
Purchase of Futures via Exchange
g ( )If a bad harvest
is expected
PriceStabilizationtakes place
d l
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Trading & Delivery ProcessSees NCEL spot and futures prices
Approaches mandi of choice
Sells futures On NCEL
Bank finance against WR
Lodges goods
in NCEL approved warehouse
Goods assayedby approved assayers
Warehouse Issues Receipt
WAREHOUSES
Issues WR
QualityCertification
NCELarranges creditthrough bank
tie-ups
Prerequisites for Commodity based
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Prerequisites for Commodity based
Financing To convert agricultural produce into a
tradable instrument Warehouse Receipt But it Requires an Institutional Framework Sound banking system Futures exchanges Price stability
Network of warehouses Collateral Managers
The Concern is warehousing and collateral managers
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Thank You