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  • 4.6.2-COTTON TRADING-CHINA

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  • China

    Chapter 4 - Cotton trading - Other futures markets 

     
     
    The Shanghai Cotton Exchange, which was established with the help of British and Japanese traders involved in the successful opening of the Osaka Sampin Exchange, introduced futures trading in 1911 trading Chinese cotton production. During the 1920s Shanghai’s cotton exchange volume equalled about one-third of the Chinese production. The trading volume fluctuated significantly in the 1930s. The Exchange closed in 1941 following the outbreak of the Second World War. In May 1977 the Hong Kong Commodity Exchange introduced a cotton futures contract, along with contracts on sugar, soybeans and gold. In its first year of operation it traded 1,151 contracts. After surviving a difficult year in 1979 with a trading volume of only 507 contracts, its turnover reached 14,630 contracts in 1980. Cotton futures trading at the Hong Kong Commodity Exchange lasted only four years because of lack of interest, and in 1981 the contract was delisted from the exchange.

    The Zhengzhou Commodity Exchange

    On 1 June 2004 The Zhengzhou Commodity Exchange (ZCE – see www.cottonchina.org) in China launched a new futures contract called Cotton # 1 Contract, and quickly achieved large volumes of contracts traded. ZCE is one of three futures exchanges in China. It was established in 1990 and in 1993 started futures trading in agricultural commodities. Wheat, sugar, cotton and pure terephthalic acid (PTA, used in the production of polyester), are the four other commodities currently traded at the exchange.

    The Cotton # 1 Contract is 5 tons (about one-fifth of the size of the New York contract) for deliverable grade 328 at 13 approved, exchange-appointed warehouses, for saw ginned cotton, with 11 trading months; February is the only month excluded. The maintenance margin is 7% of contract value (about the same as in New York) and the daily price change limit is set at 4% of the previous day’s settlement price (also about the same as in New York). The trading fee is set at 8 yuan (RMB) per contract, equivalent to about $1 per contract. Trading fees in New York range from $0.50 to $1.35, depending on the account for which the trade is executed (floor broker, member, non-member).

    The major elements of success of the ZCE Cotton # 1 Contract lie in the integrity of the contract design: it is easy to make and to take delivery of cotton with assured quality. China’s Fibre Inspection Bureau tests cotton quality at the warehouse entry point and at delivery. The base quality of the # 1 contract is grade 328, representing the bulk of cotton produced in China, but other grades are deliverable. Domestic prices in China have been highly volatile historically, encouraging market participants to hedge. Widespread familiarity with futures (obtained during the 1990s when more than 50 futures exchanges were operating) and the large number of speculators helped to create large liquidity for cotton futures from the opening day of the # 1 contract.

    The contract proved very successful. It attracted large volumes during its first year and a half of existence, exceeding at times the volumes of cotton traded in New York. Between June 2004 and December 2005 a total of 27.7 million contracts, or 138.6 million tons, were traded at ZCE. The average monthly volume traded during the period was 1.5 million contracts, or 7.5 million tons. Trading volume reached a daily record of 156,072 contracts traded on 26 October 2005, and open interest reached a record of 110,442 contracts on 11 April 2005. The largest monthly volume of Cotton Contract #1 was 2.2 million contracts in July 2005, and during the second half of 2005 volumes were close to 2 million contracts a month.

    However, cotton-trading volumes at ZCE declined sharply in 2006. Between January and December 2006, a total of 5.1 million cotton contracts, or 25.5 million tons, were traded, averaging 420,000 contracts or 2.1 million tons a month. The largest trading volume during 2006 was reached in August, when 1.1 million tons were traded, while the smallest monthly volume of 100,000 contracts was recorded in September 2006. During most of 2006, cotton prices in China were relatively stable. Coincidently, a new sugar futures contract was introduced at the start of 2006. As a result, a large volume of speculative trading in 2006 shifted from cotton to sugar, causing sugar contract volumes to rise while cotton volumes declined to a quarter of their 2005 level. Speculators dominate the ZCE futures market, while the share of hedgers is minimal. During the first four months of 2007, trading volumes in cotton futures at ZCE remained relatively low, totalling 620,000 contracts, 76% less than during the same period in 2006.

    ZCE has 222 members, including 27 that are State-owned. Of its members, 179 are futures brokerage firms, while 43 are non-futures-brokerage firms. Only 28 firms are based in Henan province. All trading is done electronically, with no open outcry. Physical delivery in all contracts has not exceeded 0.5% of traded volume. ZCE cotton prices are an important factor in determining domestic prices for physical cotton in China and are taken into account by most of the mills when making purchasing decisions. In addition to fundamentals, the ZCE prices also reflect Government actions that affect the supply and demand situation in the domestic market.

    Since the ZCE contract represents only Chinese cotton delivered to domestic locations, there is no correlation between New York futures and ZCE futures, and there are no efforts to balance trades between the two markets.

    ZCE has signed memoranda of understanding with NYBOT, BM&F and the Chicago Board Options Exchange (CBOE) aimed at sharing information and expertise, training, organizing seminars, developing new exchange products and cooperation. ZCE is working on developing new products, and cotton options could be introduced at the exchange soon.