New market to help you hedge against risks

Nairobi Securities Exchange CEO Geoffrey Odundo (left) and Chairman Eddy Njoroge. The Nairobi Securities Exchange has introduced a trading unit exclusively for high net-worth investors. PPHOTO | SALATON NJAU | NATION

What you need to know:

  • According to the exchange’s chief executive officer, Mr Geoffrey Odundo, the market would provide new investment options for investors and also help them manage risk.
  • The risk mitigation avenue arises from the fact that investors can use hedging tools to ensure that they do not lose their money.
  • In the first three years of the operation of the derivatives market at the Johannesburg Stock Exchange, currency derivatives grew at 205 per cent with index-linked ones increasing by 27.5 per cent.

Investors would soon boast of a new investment vehicle to bet their money on as they diversify from the current products on offer within the capital markets.

If all goes according to plan, a new platform — derivatives market — which enables investors hedge against market risks, would be operational starting June, this year.

This would provide a fresh investment stream with a more predictable assessment of risk and returns as opposed to trading shares on the securities market.

Already, optimism among analysts and traders is high regarding the broadening of investment options in the capital markets.

“The derivatives market is expected to increase avenues for investment and reduce investor risks as it gives investors the opportunity to know whether or not they are making money,” Equatorial Commercial Bank’s head of treasury, Mr Benard Omenda told Money.

In December 2014, Nairobi Securities Exchange (NSE) received preliminary regulatory approval to establish a derivatives market, which will be trading futures contracts and options that hedge against risk.

PRICE CHANGES

In February last year, the bourse incorporated NSE Clear, which would settle trades, collect and maintain funds for transactions and report trading data.

According to the exchange’s chief executive officer, Mr Geoffrey Odundo, the market would provide new investment options for investors and also help them manage risk. The risk mitigation avenue arises from the fact that investors can use hedging tools to ensure that they do not lose their money.

“The exchange is introducing new asset classes to provide investors with additional instruments to not only invest in, but provide tools for efficient and effective management of risk,” Mr Odundo said in an interview with Money.

The derivatives market is regarded as one of the most affordable and convenient means by which investors can cushion themselves against interest rate fluctuations, volatility in exchange rates and commodity price swings.

The NSE’s new platform would facilitate spot (immediate) and futures trading of multi-asset classes such as equities, currency, interest rate products and various forms of agricultural commodity contracts. It would benefit investors seeking a cushion against interest rate fluctuations, volatility of exchange rates and commodity price changes.

The derivatives platform would be modelled along the Johannesburg Stock Exchange derivatives market that trades futures and options on equities, bonds, currencies, indices, interest rates and commodities. In futures contracts, parties agree to buy or sell assets or commodities at a price agreed in advance during a given time in the future. Option contracts on the other hand give the buyer or the seller the right to buy or sell a given asset at a given price on or before a set date in future.

Informed decision

“If you are in the derivatives market and you know that a certain asset will be going for a certain price at a certain date in the future, you are able to position yourself and make a more informed investment decision,” Mr John Kirimi, an executive director at Sterling Capital, said in an interview.

For a start, the products to be traded will include currency futures (because of an existing over-the-counter and very active foreign exchange market, the single stock futures and the index futures (because of an existing listed and liquid stocks).

SINGLE STOCK

Single stock futures is a type of agreement between two entities to exchange a specified number of shares in a company for a price agreed today with delivery occurring at a later date in the future. Index futures are deals where buyers and sellers agree to pay or receive payment for the cash value of an underlying stock index in the future.

“The most obvious opportunity is for the market to trade and clear interest rate, foreign exchange and equity based derivatives (futures and options),” the capital markets master plan 2014 – 2023 states.

The NSE indicates that basing on conservative estimates on the analysis of early growth of derivatives markets in China, South Africa, India and Mexico, growth rates for currency derivatives between 2015 and 2017 are expected to reach 40 per cent. The growth rate for index-linked products are to hit 30 per cent while growth of single stock futures is expected to reach 20 per cent.

In the first three years of the operation of the derivatives market at the Johannesburg Stock Exchange, currency derivatives grew at 205 per cent with index-linked ones increasing by 27.5 per cent.

Single stock futures on the other hand grew sluggishly at 0.10 per cent, Mr Odundo said.

Already, the potential seems huge with Kenya’s capital markets master plan envisaging the value of outstanding exchange-traded derivative contracts to reach an ambitious $200 billion (Sh18 trillion) by the end of 2023.

Analysts, however, argue the new market may take time to attract the requisite support from local investors.

This is augmented by the fact that less than four per cent of Kenyans are active investors in the stock exchange.

Even with backroom plans to launch the new exchange, there are fears the investing public is still in the dark regarding the derivatives market and the trading procedures.

Little understanding would mean muted interest in participating in the market until such an unforeseeable time when the market would have been adequately tried and tested.

“People are still not aware of what the derivative market is all about,” Mr Omenda indicated.

Further, the capital markets master plan indicates that a derivatives market can only develop successfully if there is real demand from users for its products for hedging purposes.

ASSET CLASSES

This is owing to the fact that many derivative markets fail given that they are set up to appeal more to speculators and there is no local trading in the given assets.

The NSE says it is conducting workshops for market participants in collaboration with the industry to raise the required awareness of the derivatives exchange among retail and institutional investors.

Despite the fears on low levels of awareness of the new platform among investors, Mr Odundo is optimistic that foreign and local retail investors would be among the first to invest using the new platform.

“This is because the foreign investors already do have exposure to these asset classes.

The retail investors are usually front runners for new products especially when the products are well understood and we foresee them doing the same,” he observed.