Derivatives trading at Nairobi bourse set to start by June

Trading of financial instruments that hedge against risk on the Nairobi Securities Exchange (NSE) is set to start by end of June, ushering in a new phase in the market that will allow investors to bet on the direction of the price movement of shares and bonds.

New NSE chief executive officer Geoffrey Odundo said Tuesday that the instruments —called derivatives—trading system has been tested and it is currently going through simulation with other stakeholders such as trading members, dealers and clearing banks.

The Capital Markets Authority (CMA) issued the NSE a provisional licence allowing it to open a derivatives exchange in December, paving the way of listing of instruments like futures contracts and options which hedge against risk.

The instruments are linked to the risks inherent in the trading of the shares and bonds available on the NSE.

An investor can ensure that they do not lose money through using the hedging instruments.

However, the derivatives, being complex instruments, require proper rules and monitoring to avoid the financial crises seen in western countries in the 2008-2009 period.

“We have made major strides. We are also conducting training for the trading members, dealers and clearing banks, and we estimate that second quarter is when we are going to have the first trades take place,” said Mr Odundo, who spoke on the sidelines of a CMA forum discussing the EAC council capital markets directives.

“We are starting with single currency contracts and index contracts which we think are the easier ones to start with, but as we progress we intend to introduce agriculture commodity contracts,” he said.
Part of the Sh627 million the NSE raised during its initial public offering in August was used as seed capital for the futures exchange.

The additional capital raised helped the bourse exceed the minimum of Sh1 billion required under regulations governing the licensing of an institution to trade in derivatives.

As part of the preparation to launch trading, the bourse is in the process of recruiting a derivatives market oversight board, having advertised for applications at the end of January.

READ: NSE seeks to hire derivatives market team

The board will comprise a minimum of seven of the NSE’s own nominees, at least one of them an NSE executive. Others will include two directors of the NSE and two other individuals representing public interest.

“The committee will advise the (NSE) board on risk, strategic issues and oversight roles relating to the NSE’s derivatives market and the NSE clearing house,” said the NSE in a statement.

NSE’s planned market is modelled on the Johannesburg Stock Exchange (JSE) Derivatives Market, which offers trading of, among others, futures and options on equities, bonds, indices, interest rates, currencies and commodities.

The phased approach in the introduction of the new products has been seen as desirable by market experts, given that many investors are unfamiliar with the different types of derivative and futures products which are only common in bigger bourses across the world.

“Our approach where we have settlement in cash rather than requiring the delivery of an underlying asset is easier to deploy. This is how you get a market to take off. Johannesburg did it and it is now one of the biggest derivative markets in the world,” said SBG Securities chief executive officer Nkoregamba Mwebesa in a recent interview.

Analysts have, however, cautioned in the past that introducing the complex instruments could pose some risks for the stock exchange, drawing from the examples of the global financial crisis of 2008-2009 in which the collapse of several big banks was linked to exposure to mortgage backed derivatives.

According to the Bank of International Settlements (BIS) quarterly review to December 2014, the gross market value of global derivatives as at June 2014 stood at $17.4 trillion, indicating the huge potential the market has even in smaller markets like Kenya.