Need To Hedge for Cotton Ginners, Spinners, Exporters/Importers and Farmers etc

Type Of Commodity Market There are different type of Commodity Market: Spot Market: bought & sold for cash and the delivery takes place immediately. Physical contracts for cotton are not standardized and specific to each transaction (volume, quality, location, etc). 2) Forward Market: The trading takes place directly between the buyer & seller. Terms such as Qty, Quality, Delivery date and price and negotiated between buyer & Seller (two person only). 3) Futures Trading: Future trading in commodities results in transparent and fair price discovery due to the large scale participation from all entities associated with the value chains involved. Future market/ financial markets have uniformed standard contracts: 1) Delivery location/place, 2) Delivery procedures, 3) Quantity (Lot size), 4) Quality (like length, mic, moisture, trash, grade) and 6) Price etc Did you Know? The first organized futures market – Bombay Cotton Trade Association was started in 1875. Trading in certain commodities was stopped in 1960’s and 1970’s and resumed only in 2002-03.

What is Commodity Exchange ? In simple terms, a commodity exchange is a market place where different commodities are traded. Commodities are traded in standardized contracts of different maturities call futures contract It is regulated by SEBI Exchange has no role in pricing of contracts Buyers and sellers determine the price. In future markets, one trader’s gain is another’s loss (Zero Sum Game) What is the need of Commodity Futures Exchange ? A future exchange provides future price signals . In the absence of price signals, one has access only to current prices. a) he can not plan for the future and b) policy makers would not be able to prepare for future plan. Price Discovery Price Risk Management/Hedging.

Fund based Arbitragers (Cash & Carry) Participation Reach Exporters Brokers/ Traders Ginners Millers Retail & HNI Jobbers Spreaders Fund based Arbitragers (Cash & Carry) Other financial Value Chain Financial Players

Cotton Snapshot Approximate Indian market size : Rs. 68,000 Crores Annualized price volatility in 2016-17: 19.3% Exposure to price risk: More than Rs. 13,000 Crores Just for example 29 MM Cotton which is being traded on MCX covers more than 75% of cotton grown in India Minimum impact cost due to high liquidity

Price Risk Management (Hedging) Price risk management is very important and essential for market participants, such as farmers, ginners, traders, exporters, spinners and textile companies etc. The Concept of Hedging: Hedging is the process of reducing or controlling risk. It involves, taking equal and opposite positions in two different markets (such as physical and futures market), with the objective of minimising or reducing risks associated with price changes. It is a two step process, where a gain or loss in the physical position due to changes in price will be offset by changes in the value on the futures platform, thereby reducing or limiting risks associated with unpredictable changes in price. Reducing risk may not always improve earnings, but failure to manage risk will have direct repercussion on the risk bearers long term income. Finally, the purpose of HEDGING is to REDUCE price uncertainty and the impact of adverse Cotton price movements. It can enhance credit worthiness, ability to borrow and improve stability in profits.

Need to Hedge For reducing the price risk due to volatility, cotton stakeholders need hedging. Though, insurance companies offer suitable policies to cover the risk of physical commodity losses due to fire, theft, transport mishaps etc., similarly they do not cover the risks of value losses resulting from adverse price variations. Cotton stakeholder are exposed to heavy risk from adverse price increases on their overseas or domestic sale commitments of Cotton/yarn for delivery at a later date. Price volatility, no doubt, also brings in its wake windfall gains to market functionaries. In the long run, such gains may even offset the losses from unfavorable price changes. But the losses when incurred are sometimes so large that they may even lead to insolvencies/bankruptcies. Hence Cotton stakeholders need price hedging through the use of commodity price risk management instruments like futures contracts.

Hedging Illustration ( Falling Prices) Scenario 1: Assume a ginner is holding stocks of 1000 bales of cotton (29mm) in March. By hedging, he can lock in the price for his stock in March itself and protect himself against the possibility of falling prices. The spot price of cotton today is Rs 19,000/bale and the price of May 2018 futures contract is Rs 19500 a bale. The ginner sells (short) 40 lots of May 2018 contract in March (today) at Rs 19,500 for a delivery in May 2018. He deposits/pays only 5% of the contract value as initial margin to the exchange for entering a position in the futures market. The prices fall in May. The ginner sells his stock in physical market for Rs 18500 a bale and takes an opposite position in the futures market, by buying 40 lots of May 2018 futures contract at Rs 19000 a bale (square off). Time Cash Futures Today Spot market at Rs 19,000 a bale Sells 40 lots (1 lot = 25 bales) of May 2018 at Rs. 19,500 a bale May 2018 Sells 1,000 bales of cotton at Rs. 18,500 a bale Buys 40 lots of May 2018 at Rs. 19,000 a bale Result Loss of Rs. 500 a bale Gain of Rs. 500 a bale Thus, ginners/traders/stockists/ hedged himself from the falling prices.

Hedging Illustration ( Rising Prices) Hedging Strategy for Buyers (Exporters, Spinners, Traders): Buyers can buy their requirement of the years in a futures contract by paying a margin of only 5% and lock their prices for the entire year. They can keep on procuring cotton in the physical market round the year and square off the corresponding position in futures. Thus, even if the cotton prices goes up, they don’t incur any loss, because the profit from furfures market offsets their increased cost of procurement. Example: Suppose that today (in the month of March), an exporter receives an order to export 1000 bales of cotton in May. He is planning to buy cotton from spot market and export it in May. Assume, today’s spot prices is Rs 19,000 a bale and May contract trading at 20000 and he is worried that prices would rise by May. By hedging, he can lock in the purchase price in March itself, and protect himself from rise in prices in the spot market. He can exit before expiry of the contract (square off). Exporter buy from the physical market @ Rs. 20,000 a bale (loss of Rs 1000/bale) and sell (short) 40 lots of March 2018 contract at Rs. 21,000 a bale (gains Rs 500/bale). Time Cash Futures Today Spot market at Rs 19,000 a bale Buy 40 lots (1 lot = 25 bales) of May 2018 at Rs. 20,000 a bale March 2018 Buy 1,000 bales of cotton at Rs. 20,000 a bale Sell 40 lots of May 2018 at Rs. 21,000 a bale Result Loss of Rs. 1000 a bale Gain of Rs. 1000 a bale Thus, exporter hedged himself from the rising prices in the cash market.

Benefits of Hedging on MCX India’s No.1 Commodity Exchange to trade cotton futures. Only liquid cotton contract in India. The contract is attuned to the physical market requirements in terms of staple length, Micronaire, tensile strength, trash etc. Delivery Centers at major producing area in Gujarat, Maharashtra and Telangana. High Correlation with prices at benchmark international exchanges (about 85%). Exemption from CTT: Cotton has been put under list of commodities exempted from paying Commodities Transaction Tax (CTT). Evening Trading Permitted: The market is operational both during morning and evening, and thus participants can take part in price discovery when global markets are active. Early Pay-in: If a hedger makes an early pay-in of commodity, he is exempted from paying all applicable margins.

29 MM Cotton Contract PARAMETER SPECIFICATION Price Quote Rs./ Bale Trading Unit 25 Bales Tick Size Rs. 10/ Bale Contract Months Oct, Nov, Dec, Jan, Feb, Mar, Apr, May, Jun, Jul Expiry Date Last trading day of month Delivery Unit 100 Bales Delivery Logic Compulsory Delivery Maximum Allowable Open Position For Individual Client: 3,60,000 bales. For a member collectively for all clients: 36,00,000 bales or 15% of the market wide open position whichever is higher. For Near Month Delivery: For Individual Client: 90,000 bales. For a member collectively for all clients: 9,00,000 bales or 15% of the market wide open position whichever is higher.

Quality Specifications STAPLE LENGTH MICRONAIRE Below 28 mm = Rejected Below 28.50 to 28.0 = Discount of 2% 28.5 to 29.0 = No Premium/ Discount Above 29.0 to 30.0 = Premium 1% Above 30 to 31 mm= Premium 2% Below 3.5 = Rejected Below 3.6 and up to 3.5 = Discount of 0.3% 3.6 to 4.8 = No Premium/ Discount Above 4.8 and upto 4.90 = Discount of 0.3% Above 4.9 = Rejected TRASH ` COLOR GRADE Below 3.5% and up to 2% = Premium Of 1:0.5 Basis = 3.5% Up to 5% = Discount 1:1 Above 5% = Rejected Up to 31-3=No premium/discount 41-3 = Discount 3% 42-3=Discount 5% MOISTURE Basis = 8.5% Up to 9.5% = 1:1 Discount Above 9.5% = Rejected STRENGTH Minimum 28 GTex

Delivery Centers With Location Discount Kadi (- 50) Mundra (0) Rajkot (Basis) Yavatmal (- 100) Jalna/Jalgaon (- 75) Adilabad (- 150) Warangal (- 150)

Month-Wise Delivery & Stocks Month-wise Delivery of cotton at MCX Platform Expiry date Qty (Bales) October 31, 2016 0.00 November 30, 2016 1,200 December 30, 2016 4,100 January 31, 2017 February 28, 2017 17,400 March 31, 2017 22,400 April 28, 2017 5,600 May 31, 2017 4,800 June 30, 2017 13,100 July 2017 23,500 Total (October 2016 to July 2017) 96,200 October 31, 2017 November 30, 2017 11,300 December 29, 2017 30,900 January 31, 2018 27,700 February 28, 2018 29,100 Stocks as on March 20, 2018 Stock eligible for Exchange Delivery 1,22,900 Stock in process for delivery 6,400 Capacity of warehouse 1,52,700

Testing Agency (Wakefield) Delivery Process (WSPs: Yamada Logistcs, Orogo and Navjyoti Commodity Logistics) DEPOSITOR WH Moisture Testing at WH Samples Drawn (5 Bales) Staking Lab Testing (5 Samples) Testing Agency (Wakefield) EXCHANGE ACCREDITED WH Goods Deposited WH Receipts Issued

Impact of Commodity Futures Synopsis of Evaluation Studies a) Study by Deloitte India (2013): Commodity futures market directly generates employment for around 1.5 million personnel in India – 0.93% of India’s service sector labor force d) Study by Tata Institute of Social Sciences (2012): Futures platform has ensured stable and fair prices for the SMEs. Fairer prices reduce the cost of production and import bill, boost growth of the SMEs and provide accurate demand-supply signals that reduce risks in SMEs. b) Study by The Nielsen Company (2013): Assessing the Impact of Dabba Trading on Commodity markets in India – The Dabba Market (trades outside the regulated markets) is more than 3 times of the trading through regulated Exchanges e) Study by UNCTAD (2009): Number of intermediaries in Mentha value chain has reduced after introduction of futures market, reducing the price spread in the marketing channel from 11-12% to 7.5-10.5%. In case of Cardamom, it has helped to stabilize prices in the spot market. c) Study by IIM Calcutta and NISTADS, New Delhi (2012): Mentha Oil futures facilitated rise of India as major exporter of processed mentha crystals – transitioning from raw material exports. f) Study by IIM Lucknow (2007): Potato and Mentha Oil markets showed substantial improvements in increased price realization to farmers during the period after the introduction of futures.

How Can You Participate on Mcx Choose the Member Broker Fulfill KYC at Broker level Arrange for minimum initial margin requirement Update yourself on Mark-to-Margin requirements Know MCX regulations and byelaws Select the commodity/ product to trade Read the Dos and Don’ts Know and distinguish among: Brokerage and Transaction Charges Margins, Taxation and Stamp Duty Default Penalties and Arbitration

Do’s & Don’ts in Commodity Derivative Markets Trade only through Registered Members of the Exchange. Visit MCX web site for Members Details to check if the member is registered with Exchange Fill standard 'Know Your Client’ (KYC) form before you commence trading Update your mobile number and/or email id with your broker Insist with your Broker to upload your mobile number and/or email-id in the Exchange UCC database. Insist on getting a Unique Client Code (UCC) and ensure all your trades are done in UCC Insist on reading the standard 'Risk Disclosure Document (RDD)’ & ‘Rights & Obligation of Investor’ DON’TS Do not be influenced by indicative returns or promises made Do not get carried away by luring advertisements, rumors, hot tips Do not make payments in cash/take any cash towards margins and settlement Do not sign blank DPs while furnishing securities deposits Do not pay brokerage in excess of the rates prescribed by the Exchange

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