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    Chapter 4 - Cotton trading - Other futures markets

    The São Paulo Commodity Exchange was established in 1917. It first traded cotton futures in 1919, with a contract size of 500 arrobas (equivalent to 7,500 kg). In 1922, the trading volume reached 14,000 contracts and by 1926 cotton-related activities were the exchange’s major source of income, followed by sugar and rice. However, in the three-year period following the 1929 financial crisis the volume dropped by 90% compared to the same period prior to the crisis.

    Trading of cotton futures at the São Paulo Commodity Exchange flourished during the Second World War (unlike the European exchanges, which suspended operation), with a trading volume of 43,000 contracts in 1941 and an average of 200,000 contracts between 1944 and 1946. Political instability, restrictions on capital movements and inflation of around 40%, however, caused futures trading to decline in the early 1950s; gradually, the cotton futures market lost its importance and the contract ceased trading. Although the contract was reinstated during the mid 1970s, it never gained importance. In 1989 the contract ceased trading once more, leaving NYBOT, now ICE, as the only exchange in the world trading cotton futures.

    The recent cotton contract

    In November 1996 the São Paulo Commodity Exchange (BM&F – see www.bmf.com.br) reintroduced the cotton contract (along with numerous other commodities), and in December 1999 the contract was offered to foreign investors. In February 2000 options were introduced on all futures contracts, including cotton. Initially, the contract size was just 10,000 pounds, or one-fifth of the New York cotton futures contract. In 2002 the BM&F cotton contract size was changed to 12.5 tons or 27,558 pounds, roughly half the size of the New York cotton futures contract. The new São Paulo contract is delivered to various locations in Brazil in the months of March, May, July, October, and December. The design of the BM&F contract is very similar to that of the New York contract. The contract is quoted and traded in United States dollars per pound but is settled in real. The exchange rate used for settlement is the one reported by the Central Bank of Brazil. In effect, therefore, trading the São Paulo cotton contract also implies the undertaking of dollar-real exchange rate risk.

    It was anticipated that the contract could serve as a hedging instrument for South American cotton producing countries given that the region’s crop (part of the Southern Hemisphere’s crop) moves within a different time frame to that of the United States crop (part of the Northern Hemisphere’s crop), the principal influence of the NYBOT, now ICE, contract. The volume has been far below expectations as the contract has failed to attract considerable attention from hedgers and speculators.

    During its first year of existence, the cotton contract was regularly traded on a daily basis. However, trading volume remained relatively small, averaging just 58 contracts a day, the equivalent of about 290 tons of cotton. Contract volumes traded since 2000 remain small. During 2006 a total of 2,920 cotton contracts or 36,500 tons of cotton were traded at BM&F, compared with 3,338 contracts or 41,725 tons traded during 2005. Daily volumes averaged 12 contracts or 150 tons during 2006 and 13 contracts or 163 tons in 2005. During the first two months of 2007, BM&F cotton futures contracts totalled just 272 contracts. This lack of volume could be explained by direct competition from the NYBOT cotton futures market, as cotton market participants operating in Brazil, as well as speculators, have access to that market as well as BM&F.