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At long last the country's first Commodity Exchange (CX) has come under a legal framework with the publication of gazette notification on its rules approved by the regulatory authorities. According to a FE report, operation of the CX is set to commence soon after its registration with the Bangladesh Securities and Exchange Commission (BSEC).
Initially, the CX will facilitate non-delivery cash settlements for three commodities --- gold, cotton, and crude oil, with plans to transition to physical delivery settlement of the commodities in the future. As per the draft rules, the CX's minimum paid-up capital will be Tk 4.0 billion while the minimum paid-up capital required for each commodity broker will be Tk 100 million. The CX's board will consist of 13 members, including seven independent ones. And the chairman of the board will be chosen from among the independent directors.
The concept though new to many of us, is quite familiar in the neighbouring countries which have set up Commodity Exchanges of selected items as an effective measure of market stability. India, Pakistan and Nepal are among the neighbours who are ahead of us in setting up Commodity Exchanges. In Bangladesh, way back in 2007, the government initiated a move to establish a commodity exchange which did not materialise due to reported complexities relating to some basic infrastructure issues such as warehousing facilities.
A commodity exchange is a system of legal framework where various commodities are traded, with rules and procedures for trading standardised commodity contracts. The transactions take place either on paper or electronically. The product remains in a shop, warehouse or field. From there, it is finally disposed of or handed over after a certain time. Operations of the CX closely resemble those of stock exchanges. TREC (trading right entitlement certificate) holders execute transactions of listed securities, while commodity brokers manage the trading of commodities on the CX. Like the TREC holders, the commodity brokers will have to comply with the risk-based capital adequacy rules. In that case, the rules can be relaxed a bit for the commodity brokers.
Concerned quarters are upbeat about the prospect of the country's maiden CX. According to the Chairman of the Chottogram Stock Exchange (CSE), research has shown that the size of the commodity market in Bangladesh is more than $144 billion. Only for the country's garment sector, a huge amount of cotton has to be imported from abroad. The garment industry will benefit if the companies that buy cotton in the country and the companies that sell cotton internationally can be brought to the commodity exchange market.
According to the Securities and Exchange Ordinance 1969, any product such as agricultural items, livestock, fish, forest resources, minerals and energy products can be traded under the commodity exchange.
Through the futures market, a farmer or entrepreneur will go into production on becoming assured of the price of his products before the start of the season. In this way, the Commodity Exchange can build a secure marketing system. Through this, farmers and farmers' cooperatives will be sure to get a fair price. At the same time, there is little risk due to crop failure; so buyers are likely to get the product at a fair price. The exchange facilitates the participation of farmers alongside financing for them while the producers will have to avail of insurance.
The purposes served by a commodities exchange depend in part on the nature of the specific contracts that are traded. By simply centralising trade in a certain commodity, an exchange can facilitate title transfer, market transparency, and price discovery. Transaction costs are reduced because coordination through a centralised exchange can reduce costs associated with identifying market outlets, physically inspecting product quality, and finding buyers or sellers. By reducing transactions costs and enhancing the flow of information, an exchange can improve returns to market agents while reducing short-term price variability and spatial price dispersion.
However, while futures contracts can effectively remove price level risk, they do not eliminate risk altogether. Rather, they replace price risk with basis risk, where the basis is the difference between the spot market and futures market prices. Unanticipated shifts in the basis can result in gains or losses, and the degree of basis risk can strongly influence the effectiveness of the exchange in risk management.
The important aspect of Commodity Exchange is that it helps increase the liquidity for farmers since it assists them to access funds without any interest. According to experts, a commodity exchange allows farmers to lock in prices using forward contracting. This also reduces the risk of a drastic price drop. As a result, they do not need to borrow at higher interest rates from sources such as banks or usurers.
There are indeed many pros and cons, not as simple as it apparently looks, which need to be familiarised with before embarking on the new mode of exchange marketing in the country. Keeping this in view, the CSC has signed a memorandum of understanding (MoU) with the Multi Commodity Exchange of India (MCX) to appoint it as a consultant. In 2003, MCX became one of the first exchanges to open in India. It provides a platform for price discovery and risk management across varied segments, including industrial metals, energy and agricultural commodities. MCX will recommend bylaws and regulations based on generic regulatory compliance and international best practices, products, clearing and settlement methods, trading and surveillance systems, warehousing, delivery infrastructure and partnership models.
As of now, most people associated with stocks, including economists, have welcomed the move. Many hold the view that inclusion of horticulture products like potato, onion, spices, tomato among others would be a huge turning point, if fair price could be ensured through the exchange to the benefit of both the growers and consumers. In order to make the relevant quarters, including farmers and business community, familiar with the functioning and technicalities involved, the authorities concerned need to launch a country-wide campaign and arrange dissemination workshops. The media can also be taken on board to raise literacy in Commodity Exchange.