Malaysia Financial Law - Commodities Law

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FINANCIAL LAW - Commodities Law

Related Topics : Banking Law . Offshore Banking Law . Broker Disputes . Commodities Law . Investment Terms . Raising Capital . Securities Law . Buying On Hire Purchase . Exchange Control Rules . Danaharta Act

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Commodity Futures

The Kuala Lumpur Commodity Exchange (KLCE), established in 1980, caters for futures trading in commodities.

Presently, the futures contract traded at the KLCE is the Crude Palm Oil (CPO) futures. All futures contracts traded on the KLCE is registered and cleared by the clearing house known as the Malaysian Derivative Clearing House Bhd. (MDCH).

With effect from 16 April 1997, the KLCE functions under the supervision of the Securities Commission and is regulated by the Futures Industry Act 1993 (FIA) which replaces the Commodities Trading Act (CTA).

On November 17, 1998, Commodity and Monetary Exchange of Malaysia (COMMEX Malaysia) announced the merger between COMMEX Malaysia (formerly know as The Kuala Lumpur Commodity Exchange, KLCE) and its subsidiary, Malaysia Monetary Exchange Berhad (MME) would take place on December 7, 1998.

WHAT ARE COMMODITY FUTURES ?

Futures contracts and options on futures contracts exist for a wide range of products, including agricultural products such as rubber, cocoa and crude palm oil, natural resources such as petroleum and gas, precious metal such as gold and tin, financial instruments such as stock indices, and interest rates, and currencies such as the US Dollar and the British Pound. At COMMEX Malaysia, the underlying products for its contracts are Crude Palm Oil and the 3 -month Kuala Lumpur Inter-Bank Offered Rate (KLIBOR). More contracts will be introduced in the future pending on the needs for more risk management instruments of the industries.

WHAT IS FUTURES ?

Futures are contracts that are legally binding agreements, made on the trading floor of a futures exchange (or via an electronic screen dealing system), to buy or sell the underlying product at a specific time in the future for a specific price determined today.

A futures contract can either require physical delivery of the underlying product or be cash settled. A cash-settled contract requires a cash amount to be paid on the contract expiration day which reflects the difference between the initial futures price and the price of the underlying product at settlement. Deliverable contracts, on the other hand, require the buyer to take delivery of the physical commodity and the seller to deliver. In most cases, actual delivery seldom takes place as the contracts are closed out prior to the expiration date. A trader who has bought a futures contract can close out by selling the same number and type of futures contract he bought and vice versa. The CPO Futures contract is a deliverable contact and the KLIBOR futures is cash-settled.

WHO ARE THE FUTURES MARKET PARTICIPANTS ?

Market participants fall into three broad categories :

Hedgers : Producers or users of physical commodities who seek protection against adverse price changes by initiating a position in the futures market as a temporary substitute for the sale or purchase of the actual commodity.

Speculators : Private investors who attempt to profit from anticipated commodity price changes. They do not usually own or use the underlying product.

Arbitrageurs : People who attempt to profit from temporary distortions or inconsistencies in prices.

Speculators and arbitrageurs assume risk in hope of profits and thus provide the liquidity needed for hedgers to buy and sell in large volumes with ease.

	Reasons for buying futures contracts	Reasons for selling futures contracts
Hedgers	To lock in a price and obtain protection against rising prices	To lock in a price and obtain protection against declining prices
Speculators	To profit from rising prices	To profit from declining prices

WHAT IS FUTURES EXCHANGE ?

A future exchange is a centralized and organized marketplace for trading futures. It is made up of members, committees and staff. All futures exchanges have a clearing house to clear and guarantee its members trade.

The Clearing House
All transactions at the Exchange must be executed by or through an exchange member and every trade must be cleared by a firm that is a member of the clearing house. Once a trade has been cleared, all connections between the original buyer and seller are severed and the clearing house assumes the opposite side of the trade, that is, it becomes the buyer to every seller and the seller to every buyer, thus minimizing counterparty risk.

Margins
One of the most important financial safeguard in assuming performance on futures contracts is the margin system. Margin is the amount of money buyers and sellers of futures contracts must deposit into their accounts to assure contract performance. The brokerage firm establishes the margin its customers must maintain depending on certain minimums set by the clearing house.

If a change in the futures price results in a loss on an open futures position, funds will be withdrawn from the customer's margin account to cover the loss. In the event that his account balance falls below a certain level, the customer must promptly deposit additional money to comply with the minimum margin requirement.

On the other hand, if a price change results in a gain, the amount of the gain is credited to the customer's margin account. These margin accounts are settled daily and a customer may choose to make a withdrawal from his margin account at any time on condition that the balance does not fall below the minimum margin requirement. After an open position has been closed out, any money in the margin account not required to provide margin for other open positions (or to cover any loses) can be withdrawn by the customer.

Information compiled and partially extracts
from COMMEX Malaysia

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