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Introducing NCEL Karachi Thursday, September 9, 2004. Background. NCEL established on April 20, 2002 Permission granted by SECP on May 16, 2002 Present Shareholders: KSE-40% LSE-10% ISE-10% Pak Kuwait Investment Co. – 10% Zarai Taraqiati Bank Ltd. – 10%

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introducing ncel karachi thursday september 9 2004
Introducing NCEL


Thursday, September 9, 2004

  • NCEL established on April 20, 2002
  • Permission granted by SECP on May 16, 2002
  • Present Shareholders:
    • KSE-40%
    • LSE-10%
    • ISE-10%
    • Pak Kuwait Investment Co. – 10%
    • Zarai Taraqiati Bank Ltd. – 10%
  • Another FI has an approval for a 10% equity stake
  • First de-mutualized exchange in Pakistan
  • Firstfully integrated electronic exchange capable of also handling financial futures
  • First to employ modern risk management techniques – Value-at-Risk
  • Firstto introduce the concept of “The Central Counterparty”
  • First to introduce Vault Receipts and Warehouse Receipts
  • First to become a “Digital Certification Authority” in Pakistan – secure network access
  • First to deploy “Live Communications Sever”
mission vision

Limited access

Price distortions

Wide spreads or one way quotes

Absence of standardization

Counterparty risk

Impediments in financing

Lack of long term funding or there is a mismatch


Equal access to all

Observable future prices

Narrow spreads and two way quotes

Quality certification & standardization

Central Counterparty

Ease in financing

Vibrant long term market


“To provide an opportunity to the farmers to farm for the market”

benefits of a derivatives exchange
Benefits of a Derivatives Exchange
  • Helps in price discovery of both cash and futures
  • Helps in transferring risk – averse to risk to someone with an appetite
  • Helps in transforming cash markets into vibrant markets
  • Helps in transitioning investors into a more controlled environment
  • Helps in entrepreneurial activity in an economy
  • Helps in creating savings and investments in the long run
  • Helps in developing intellectual capital and awareness - enhances markets image and standing, and leads to an increase in FDI
360 company update
360° Company Update
  • Hardware and software fully installed
  • Members and their clients – Mock Trading
  • Gold will be the first contract to be listed
  • Regulations are ready and are to be approved by the Board and then SECP
  • Clearing Bank has been appointed for online bank transfers (MCB)
  • Cotton Yarn, Rice and Wheat contracts are being developed for Q4
360 company update cont d
360° Company UpdateCont’d….
  • 181 Members have been trained so far
  • Staff is highly educated and experienced in trading futures, risk management, IT, investment banking, agriculture, textiles, financial mathematics, operations, corporate & securities law, stock-broking, accounting, tax, process improvement, etc……
  • “Go Live” ?
key drivers of success
Key Drivers of Success
  • Provide a transparent platform for easy and equalaccess to all participants
  • Regulations will provide complete confidence and protectionto investors and users
  • Risk Management, and Surveillance & Monitoring will be based on the international “Best Practices”
  • Developing thoroughly researched contract specifications
  • Conflict of interest clearly defined
  • Un-businesslike conduct, misconduct and un-professional conduct have been introduced
  • Board does not have the right to waive compliance
  • Incorporated Corporate Code of Governance and “Best Business Practices”
  • Committees only have recommendatory powers
risk management
Risk Management
  • Pre-trade risk checks
  • Clearing Deposits & Clearing Limits
  • Position Limits – Members & Clients
  • Variation margin – T+0 settlement in cash
  • Value-at-Risk methodology using Extreme Value Theory
  • Provision for intra-day margin calls
  • Exchange reserves the right to enforce special margins
  • A quantum leap ahead of the OTC market
advantages of var
Advantages of VaR
  • It captures an important aspect of risk

in a single number

  • It is easy to understand
  • It asks the simple question: “How bad can things get?”
  • VaR models will be continuously back-tested and stress-tested
margining example
Margining - Example
  • Example – Gold
  • VaR for Clearing Limit = 2 * Sigma = 3%
    • Clearing Deposit: Rs1.0 million = x 33.33
  • VaR for Initial Margin = 4 * Sigma = 5%
    • Initial Margin: Rs0.5 million = x 20.00
  • Initial Margin: 99% VaR over 1 day
  • Spot/Delivery Month Margin: 99% VaR over 3 days
pre trade risk management
Pre-Trade Risk Management
  • Against an initial margin
  • Can also set:
    • Maximum click trading limit
    • Maximum order size
    • Maximum sum of contract size limits
    • Maximum long positions
    • Maximum short positions
    • Maximum intra-day loss

Pre-Trade Check









If P or C (SODNLV)


Order Margin



Back Office








Matching Engine


BANK Accounts



Initial & Variation Margins

Daily Sweeping of accounts

Daily Account Swipes

ncel is central counterparty
NCEL is Central Counterparty
  • Upon matching of a trade, NCEL becomes a buyer to every seller and a seller to every buyer and guarantees settlement
  • The risk of each counterparty is transferred to a Central Counterparty (CCP)
  • CCP is fundamental to the existence of a derivatives market
  • NCEL has made an initial contribution of Rs100 million to its Settlement Guarantee Fund
bilateral versus ccp multilateral
Bilateral versus CCP (Multilateral)






central counterparty
Central Counterparty
  • Benefits of CCP:
    • Acts as a Central Bank to Clearing Members
    • Simplifies Risk Management
    • Creates Process Efficiency
    • Increases Liquidity
    • Anonymity
    • Standardization of Processing
  • Clearing Members are jointly and severally liable to ensure replenishment of the SGF, in case of a major payout
online market surveillance
Online Market Surveillance
  • Clearing Limits
  • Position Limits
  • Crossing Trades (Member/Client) – 5 seconds standing in the market
  • Wash Trading
  • Front Running
  • Trading Opposites – pre-arranged trading
trading @ ncel
Trading @ NCEL
  • Single Electronic front end trading platform accessible up to the client level
  • Using a single front end for trading on Multiple Markets
  • Centralized Clearing & Settlement Infrastructure
  • Multilateral Netting
  • Cross Margining if we run multiple markets
trading @ ncel cont d
Trading @ NCEL Cont’d…
  • Front End Trading Platform should provide:
    • Can be used for accessing multiple markets (J Trader being used by over 6,000 traders for accessing 13 Electronic Exchanges with 500,000 futures contracts being traded every single day)
    • H Trader (hand held device such as a Palm Pilot)
    • Efficient screen based trading
    • Complete anonymity
    • Order driven with price/time priority
  • Features & Functionalities:
    • Pre-Trade Check based on an initial margin for all
    • Setting trading limits based on an initial margin
    • Monitoring of Clearing Limits in real time
    • Monitoring of Position Limits (Members and Clients) in real time
    • Bank transfers
    • Capability of handling shares as collateral
    • Back Office ledgers - accounting
    • Share release and bank transfer instructions
agriculture sector
Agriculture Sector
  • Platform for price discovery and hedging of price risk for farmers
  • Provide a mechanism to lenders for moving into collateralized commodity financing
  • Introduce quality standardization
  • Impetus for investment in infrastructure
  • However, the pre-requisite would be an efficient and a well developed out reach awareness program
wheat price comparison between major minor markets of pakistan for three years
Wheat Price Comparison between Major & Minor Markets of Pakistan(For Three Years)







Red = Average of Three Major Markets

Yellow = Average of 9 minor Markets




Source: Federal Bureau of Statistics

commodity based financing
Commodity Based Financing
  • Structured form of financing with an objective of transferring risk from an entity to a commodity
  • In discussion with an NGO to undertake financing as a pilot project on the following basis :

1. Pre-sowing for inputs against NCEL contract (short) and social collateral

2. Post-harvest and upon storage against a warehouse receipt

analytics @ ncel
Analytics @ NCEL
  • Risk Management
    • Should not be viewed as static
    • Time value of money
    • Being a CCP would require huge amount of risk absorption
    • Using VaR to quantify and manage this risk
    • Initial Margin and Clearing Deposits to be determined using VaR
  • New Product Development
    • Benchmark Yield Curve
    • Interest Rate Risk
    • Interest Rate Futures
    • Stock Index Futures
what is wrong with ytm
What is wrong with YTM
  • A bond’s computed YTM will only actually be earned if cash flows are immediately reinvested
  • One cannot use YTMs of existing bonds to price a new issue
  • YTM is not a pricing kernel
  • YTM believes the yield curve is flat; it is not a path to thinking and understanding a non-flat yield curve
  • It plays no role in the economics of fixed income markets
zero coupon yield curve
Zero Coupon Yield Curve
  • Provides a benchmark for valuing GOP securities across all maturities irrespective of liquidity
  • To study impact of monetary policy
  • Will help in asset and liability management of institutions with substantial investment in GOP securities
  • Has multiple uses including deriving forward currency rates
  • Will take Pakistan a step closer to international markets
deriving zcyc
Deriving ZCYC

Three main issues:

1. Given a series of GOP securities, how do you construct the yield curve?

a. Linear Extrapolation

b. Bootstrapping

c. Cubic Splines

2. What GOP securities data should be used to construct it?

a. Primary auction data – last 6 months

b. Secondary market data – individual instruments

  • What technique?

a. Nelson Siegel

b. Extended Nelson Siegel

net interest margin
Net Interest Margin

*Source: THK Banking Survey 2003


1. All markets, other than Pakistan, have efficient screen based exchange traded interest rate hedging products

2. All markets, other than Pakistan, have benchmark yield curves

net interest margin34
Net Interest Margin

Source: Malaysian Institute of Economic Research Publication

present money market
Present Money Market
  • Market trades on the YTM curve
  • OTC – impedes price discovery
  • Fragmented information - an impediment to liquidity
  • Credit risk
  • Extreme concentration
  • Lack of Hedging Opportunities
developing interest rate futures contract specifications
Developing Interest Rate Futures Contract Specifications
  • A 8.0% 2014 PIB new issue (example) will be quite liquid
  • Could it be used as underlying for a interest rate futures contract?
  • Problems:
    • Short squeeze
    • It would no longer be ’quite liquid’ in the future
    • It does not directly link up to hedging needs
our approach
Our Approach
  • Cash settlement to notional zero coupon bond
  • Interest rate futures based on the notional

T-Bills & PIBs

  • Trading such a contract will not require spot market infrastructure - billions being transferred on a daily basis
  • Eliminates “Cheapest to Deliver” games
interest rate futures contract
Interest Rate Futures Contract
  • Notional 90 day & I Year T-Bills, Notional 5 Year PIB with Coupon, Notional 10 Year Zero Coupon Bond, etc.
  • Duration of Contracts – varied
  • Listing Frequency - initially, one every month
  • Cash settlement
  • Lot size, tick size, price steps, order size, etc. to be determined together with market participants
  • Base price to be determined using theoretical futures price - ZCYC