Sayed Shoeb Pens Winning Essay for ACSA International Cotton Institute

For many years, Meister Media Worldwide has conducted an essay contest for students attending the ACSA International Cotton Institute, held annually in Memphis, TN.  The contest is open to all members of the Institute class who choose to prepare and submit an entry focusing on a key topic of interest to the international cotton industry.

Sayed Shoeb of Noble Natural Resources India submitted the winning essay for the 2014 class.

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The editors at Meister Media Worldwide congratulate him on this honor, and we are pleased to share his essay with the global cotton community.

 

 

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World Cotton Contract – Blueprint to the Next Big Change

 

By Sayed Aamir Shoeb, Noble Natural Resources India

 

What started as the New York Cotton Exchange in the 1870’s is now trotting towards its first ever truly global contract, which heralds the beginning of a new era in cotton trading.

Scheduled to start in the fourth quarter of 2014, this contract will incorporate growths other than the U.S. With the major growths like India, Australia, Brazil, Benin, Burkina Faso, Cameroon, Ivory Coast and Mali added as the deliverable origins and the delivery points to include Australia and Malaysia in addition to the earlier U.S. delivery points, it opens a huge window of opportunity and will dare the traders to expand and alter their perspective of cotton trading.

However, before going live with the contract, a number of issues and details need to be chalked out and discussed in great detail to make this contract a success, especially the new deliverable origins.

Increased participation from the other parts of the world necessitates the presence of a global contract. India for long has been the second largest producer, as well as the second largest exporter of cotton to the world. In spite of having local domestic futures markets like MCX and ACE, they do not provide sufficient liquidity and have not been very ideal to provide the required hedge to the market participants.

With the introduction of the world contract and an option to deliver Indian cotton, we should see an increased participation from countries like ours in the global market, which, in turn, will increase the liquidity. Local merchants with deep pockets will be more confident in managing their position with a globally-traded risk management tool by their side, which will be highly liquid, giving them the option to give delivery to the exchange. It will also encourage such merchants to enter other markets and trade at a global level.

Especially with a country like India where the government plays an important role in governing the extent of export, it will be a great opportunity for Indian traders to enter foreign markets like Australia and Africa, managing the risk at the same time through the world cotton contract and diversifying their portfolio, giving them the option of switching crops in case of export bans. Moreover, with the introduction of two major southern hemisphere crops, we might see an increased participation on the October delivery month.

With the introduction of this contract, however, there could be a tectonic shift in the way cotton is handled and marketed now in India. If the contract is able to garner enough liquidity, it will push the Indian stakeholders to move towards international standards from the traditional marketing style.

Today, most of the cotton marketed in India is based on the earlier type sample names that have been adapted like Shankar-6, J-34, and Mech, etc. With the world communicating based on International standards, we might see these names getting obsolete in times to come. This would lead to standardization of cotton contracts and will remove the ambiguity between the quality sold and the quality delivered.

Today, the most famous Indian variety that is getting traded internationally is Shankar 6, which is mostly grown in the Gujarat region. This, as such, is a bit unfair to similar varieties of cotton grown in other parts of India like Maharashtra and Andhra Pradesh which trades at a discount to Shankar-6 because of its high demand, irrespective of the fact that the quality is just as same. The sellers in the Indian market will have a wider basket to choose from when delivering a 31-3-36 or any other deliverable HVI standard.

Today, we see a lot of seed cotton being moved from Maharashtra to Gujarat in order to get that extra premium for getting labeled as a Gujarat Shankar-6. In times to come when the buyers acceptability will be based on the HVI standards and not on the type name, we might see a reduction of such movements and a more homogenous pricing system.

With the option of delivering cotton from other origins, the issue of market squeeze can be avoided. Trading multiple growths as per the current standard makes it a very good sellers’ market. However, the buyers have little to celebrate. With no choice of selecting the origin for take-up, they have no option but to take delivery of whatever growth is being put on the board. As far as the buyer is concerned, this will be a vital question, since the quality that is being delivered on the board will be a mix of contaminated and contamination-free cotton.

Countries like India and Africa do not have machine-picked cotton, and this brings in a huge disparity in terms of quality as compared to Australian and Brazilian cotton. The Indian and African cotton will be traded at a discount, but the buyer will always be doubtful about the quality until he receives it. Moreover, the price gap is sometimes as wide as 10 cents between Australian and Indian cotton.

A mill which needs contamination-free Australian cotton will have nothing to do with the Indian cotton in case the seller delivers low-priced Indian cotton just because it was the cheapest available tenderable cotton at that time. This is not beneficial for the mills. At this point of time it seems fair to mills if only Brazilian and Australian cotton were selected for delivery to the exchange, as it would give more confidence to the mill buyers and would lead to an increased participation from their end. However, it is yet to be seen as to how the whole system develops before giving a verdict.

Trading Indian cotton on the international exchange comes with its own set of caveats. To date, the Cotton No. 2 contract has been a U.S.-based contract, and the USDA has taken great measures in assessing the quality standards that have been delivered. One hundred percent bale-by-bale HVI assures the delivery of right quality of every bale of cotton.

The Indian market, however, has not yet matured to that level. A two percent manual sampling is still the norm for physical trade. ACE came up with a set of rules for the sampling process of cotton bales for delivery, wherein the sample size is five percent. The homogeneity of the remaining 95 percent remains a question for which the seller has to give a legally binding indemnity to the warehouse at the time of deposit of cotton bales.

However, ICE cannot rely on such measures while trading internationally. Moreover, there is no standardization of bale size, weight and packaging globally. This needs to be addressed by the ICE, since every country has its own set of standards.

With the Indian and African cotton comes the problem of contamination and extraneous matters. The Growth PND needs to take these into account. A 100 percent HVI for delivery of Indian crop could make it very costly for Indian merchants and might not be a very good proposition. In case the HVI needs to be done in Malaysia, it would be very risky for the seller to ship the cotton all the way to Malaysia and, in case the bales get rejected, it would be an additional loss to the merchant. Therefore, it becomes very important to devise a system wherein the HVI testing for futures delivery could be done at the origin.

This brings in the question of tagging the bales for delivery and making sure that the ones that are getting tagged and tested are the ones that are actually getting delivered. ICE needs to develop a robust delivery and testing system in line with the ones that are being practiced in the U.S. like the EWR to make the contract a success.

An origin-based delivery might be helpful as far as HVI testing and tagging are concerned, but possible export bans by the Indian government render this option unviable. Therefore, more discussion needs to go into the delivery system before adapting one.

To conclude, the industry cheers and welcomes the new cotton contract, but only time will tell whether this contract is a success or proves to be another lost cause. The market participants do understand the importance of a world contract, and ICE needs to collaborate and understand the requirements of each and every participant. They also need to make sure that it is supported by large hedgers and, at the same time, should not suck out the liquidity from the Cotton No. 2 contract.

The key to a successful contract is to garner liquidity within the early stages of its launch, and to garner liquidity means to have the approval of the complete supply chain from the grower to the end user.

World cotton contract is the change that industry needs today, and I hope that ICE is successful in its endeavor.

 

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