Market watchers weigh options on futures contracts

An International Monetary Fund study that recommends the trading of derivative instruments to help Kenya and other East African countries manage portfolio and business risks has sparked off debate on whether the region is ready for the type of securities that set off the global financial crisis.

The study titled The Derivatives Market in South Africa: Lessons for Sub-Saharan African Countries recommends the set up of a regional exchange in derivatives given the small nature of national economies but some fear the continent does not have the foundations yet for such complex financial products.

Statistics show that the market for over-the-counter derivatives in South Africa has expanded from $8,436 in 2001 to $15,042 in 2007, representing a growth of 78 per cent over the six years.

In contrast, emerging markets —which include China, Brazil and India — South Africa took nearly 10 per cent of the market by 2007 from five per cent in 2001, meaning that it doubled as other countries stagnated.

The study will strengthen the case put forward by the Global Board of Trade (GBOT), a Mauritius-based international derivatives exchange, which revealed last December that it was in talks with some Kenyan firms on ways to introduce some derivative products locally.

GBOT said it met with executives of the Central Bank last November with a view to starting off with regional currencies being quoted against world majors at the Mauritius platform.

However, Mr Maina Mwangi, the former managing director of Equity Investment Bank, told Business Daily that the infrastructure for trading in derivatives was not in place in Kenya and in many African countries.

“We also need skills for this type of trading in Kenya or other countries in the region. But we don’t have enough of those,” said Mr Mwangi.

But Mr Alex Mwangi, a researcher and analyst at Faida Investment Bank, said that there had been an influx of market operators who had returned from abroad — in the wake of the global financial crisis — and who could trade in derivatives if the securities were introduced.

He also pointed out that the size of the Kenyan economy as well as those in the east African region was small while their stock markets were not as liquid as is the case in more developed economies.

“The market also needs education so as to understand the products. Everybody has to be prepared,” Mr Mwangi said.

He argued that derivative instruments do not exist in isolation from the rest of the markets since they are an offshoot of the others.

He said the fact that the primary markets were still at the infancy would work against a thriving derivatives market in Kenya and the region.

“The smaller the size of the other markets, the less likely you are going to have a derivatives market,” said Mr Mwangi.

Market capitalisation for the Nairobi Stock Exchange is about $12 billion, Uganda Securities Exchange is about $4 billion, Dar Stock Exchange is about $3.7 billion with an insignificant amount of trading at the Rwanda Stock Exchange and no trading in Burundi.

The combined market capitalisation is a paltry $20 billion in the EAC against South Africa’s Johannesburg Stock Exchange with equities capitalisation of $650 billion.

Under the GBOT proposal for currency derivatives, companies could sign contracts to buy foreign currency for future delivery at a certain price thereby hedging against feeling the full blow of adverse foreign exchange movements.

In South Africa, currency derivatives reached $11,000 in 2007 compared to $4,474 for interest-derived transactions.

Higher volatility

Apart from insurance against volatile capital flows and financial risks attendant to volatility of asset prices, IMF said derivatives could yield a more efficient allocation of capital and cross-border capital flows.

It would also create more opportunities for diversification of portfolios, facilitate risk transfer, price discovery, and more public information.

However, the study by Janet Adelegan Olatundun cautions that derivatives can achieve just the opposite — financial crisis, capital outflows, and higher volatility if not well regulated.