An investor at the Nairobi Securities Exchange. The bourse expects to introduce new, riskier trade products. NATION | SALATON NJAU
What you need to know:
Sh627m - The amount of money that the Nairobi Securities Exchange is seeking to bring its capital to Sh1.1 billion.
The Nairobi Securities Exchange (NSE) is expected to raise Sh627 million in additional capital to allow it to introduce the trading of new types of financial instruments.
Analysts, however, caution that introducing complex instruments could pose fresh risks for the 60-year-old mart. The NSE is looking to bring its capital to Sh1.1 billion, exceeding the minimum of Sh1 billion required under rules crafted last year that will allow it to begin offering trade in derivatives. These are special securities whose price is dependent upon or derived from one or more underlying assets.
Some stockbrokers had argued that putting such a high capital requirement for trading derivatives would edge out the NSE and leave the market to billionaires who might want to set up a competing exchange.
However, their opposition gave way when Parliament amended the Capital Markets Authority (CMA) regulations last December to give the exchange up to three years to raise its capital to Sh1 billion, which is now possible with funds raised from its ongoing initial public offering (IPO).
Some experts suggest a phased approach in the launch of products like derivatives, short-selling and margin trading since many investors may be unfamiliar with products which are only found in advanced and busier bourses such as Nigeria and South Africa.
In more advanced markets, derivatives based on equities, bonds and commodities, have a bigger share of the market than equities or bonds.
Short-selling is the sale of a security that is not owned by the seller or which the seller has borrowed in the belief that the price will decline, enabling the seller to buy it back at a lower price than the one at which it was initially priced. But there is always the possibility that the price will rise forcing borrower to buy at a loss.
Margin trading involves borrowing money specifically for buying securities and is widely practised in some developed markets. An investor borrows cash from brokers using his existing securities as collateral.
“Short-selling is not legal in many countries, but you will find it in advanced markets. It can be quite tricky because of its speculative nature and the tendency to drive prices of the targeted securities down,” said Alexander Muiruri, head of fixed-income at Nairobi-based brokerage house Kestrel Capital (East Africa).
Mr Muiruri, however, said the bourse can introduce margin trading first before going into derivatives and then finally short-selling – which exposes the market to possible manipulation by muscled traders.
“Margin trading is not as involving as short-selling, so it can be introduced first before you bring in the other products,” said Mr Muiruri. The introduction of the products once the bourse crosses the Sh1 billion mark is seen as boosting its revenues since shareholders will expect a decent return for their investments.
Market to billionaires
“The offer places the bourse’s capital way above the Sh1 billion requirement for derivative introduction. Derivative trading is likely to add approximately Sh15 million to Sh20 million to the top line (annually),” says an analysis by Old Mutual Securities.
Derivatives are expected to start with the futures trading where people can secure prices for securities or goods they want to sell or buy in future. One of the major advantages or risks of margin trading is that it has the effect of magnifying any profit or loss made on the securities as more is borrowed than cash immediately available to the investor for trading. Again, cash-rich brokers are willing to transact more business by lending to clients who already hold other securities.
Mr Muiruri said that introducing short-selling too soon could push prices of equities and bonds down because short-seller intentions are based on lower-than-buying prices.
“Perhaps it is not yet time to introduce short-selling. It is often practised in more mature markets. You see, it can easily drive prices of securities down,” said Mr Muiruri. Even the NSE recognises that there are some risks to its rosy outlook such as the new initiatives or products, some of which are in its control but others that are not.
