DERIVATIVES TRADING AT THE NSE SET TO START IN JUNE

Derivatives trading

Finally, the long awaited derivatives trading at the Nairobi Securities Exchange (NSE) is set to kick off from June 2015. The Nairobi Securities Exchange (NSE) was able to secure a derivatives trading licence late last year from the Capital Markets Authority (CMA). This will be another stride for the Nairobi bourse ahead of other players in the region. Nairobi Securities Exchange (NSE) is set to open up a globally competitive derivatives market where spot and futures trading of multi-asset classes including shares, bonds, currencies, interest rate products as well as agricultural products' contracts will be trading. This will be another great move ahead for Kenya in becoming a regional financial hub.

According to the Nairobi Securities Exchange (NSE) CEO Geoffrey Odundo, the derivatives trading system has been tested and is currently undergoing simulation. Various stakeholders including dealers, trading members and clearing banks are now undergoing training on the highly complex financial instruments. Nairobi Securities Exchange (NSE) used part of the proceeds it obtained from its IPO when it self-listed in 2014, to develop the derivatives trading system, while the other proceeds would be used for introduction of REITS and ETFs.

Basically, derivatives are financial instruments used to hedge against adverse movements in the prices of their underlying assets. They are primarily instruments for hedging against financial risks by corporations or individual investors. They are more flexible and diversified unlike insurance products. This means that they are able to hedge some extra risks that conventional insurance products cannot cover, for instance foreign exchange risk, interest rate risk, etc.

However, derivatives are highly complex and can lead to monumental losses if not properly understood. The core purpose of derivatives is to manage risk but greedy investors wanting to make a quick buck may end up incurring detrimental losses. This is why every market player in the derivatives market must understand the inherent risks associated with these securities. For instance, the 2008-2009 financial crisis was catalyzed by some 'toxic' derivatives. The scale of losses witnessed was unprecedented. Investors lost billions of dollars, investment bank Lehman Brothers collapsed, American Investment Group (AIG) faced a possible meltdown and had to be bailed out by the US government to a tune of US $15 billion, not to mention the devastating effects on the global financial markets.

As the Nairobi Securities Exchange (NSE) braces itself to launch the trading of derivatives, it is currently in the process process of recruiting a derivatives market oversight board, whereby it advertised for applications at the end of January. The board will oversee the activities of the various market players and impose regulations to protect investors from manipulation.

The Nairobi bourse is cautiously optimistic that derivatives trading will be a great move for the Kenya's capital market. Personally, I think the introduction of derivatives is long overdue and will help the Kenya's economy in the sense that entrepreneurs will be able to uptake more risks and hence more new businesses will open up and existing businesses will expand and the overall effect is that the economy will grow.

AGRIBUSINESS AND COUNTY GOVERNMENTS

Agribusiness

I firmly believe that the agricultural sector in Kenya has a huge potential to impact the lives of a wide section of Kenyans who are farmers and continue to live in dire poverty. We grew up being taught that agriculture is the backbone of our economy, but the irony is that majority of farmers continue to languish in poverty. This is because the previous governments have failed to build structures that will prevent farmers from exploitation by middle men and more importantly they ignored the issue of value addition. For instance, farmers export raw coffee abroad, where it is processed and later the coffee is imported back to Kenya and most of the farmers can't afford it.

The market for agricultural products in Kenya is also poorly developed. At some point, there was 'shortage' of maize in the country which was making flour prices to skyrocket but ironically, some farmers in various parts of the country had maize rotting in their farms since there was 'no market' for the maize.

In my opinion, devolution is a big stride in addressing this issue. unfortunately for us, we have a shortage of transformative and visionary leadership. Majority of our leaders are political shenanigans with mediocre management skills and are using strategic plans they probably downloaded from the internet. Having said so, we still have a few leaders who are working round the clock to develop their counties.

First of all, let me laud the efforts of Muranga's governor Mwangi wa Iria for his transformational leadership in Muranga county.Key in his manifesto was his pledge to refurbish the agricultural sector in Muranga county. He sought the expertise of the international firm Deloitte & Touche who helped him draft his master-plan.  Currently, some of his developments are Kes 50 million fertilizer and seed subsidy targeting about 6500 farmers, Kes 200 million irrigation scheme covering 1000 acres of land and benefiting 10000 farmers, Kes 500 million in purchase of 35 milk coolers for every ward and the formation of Muranga Investment Cooperative Sacco. The governor has also successfully facilitated the acquisition of a ready market of agricultural produce for farmers who are affiliated to cooperative societies, for instance  members of Muranga County Horticulture Growers Cooperative have been offered a ready market in the UK and will be receiving Kes 60 per kg of french beans as compared to Kes 35 they previously received from middlemen.

Mwangi wa Iria has demonstrated a people oriented leadership and has given other political shenanigans a wide berth. He is a good example of how agri-marketing and cooperative development should be a priority for all counties so as to uplift the livelihoods of Kenyans. If other governors of other counties could emulate him and adopt such agribusiness models, Kenya's economy would realize unprecedented growth.

There is a dire need to create robust cooperative societies that are professionally managed and regulated to ensure they benefit the farmers. The governors should also work in revamping the existing cooperative societies to ensure they are better managed. They should employ professional marketing practices both inside and out of the country to tap more markets for agricultural products. The cooperative societies should also conduct civic education to farmers on best practices and also inculcate value addition for various agricultural products. This will help to reduce the middlemen headache and increase the returns for farmers.

THIS IS WHY THE GOVERNMENT SHOULD RETHINK CAPITAL GAINS TAX

illustration of the fall in trading volumes

In January 2015, the Kenya Association of Stockbrokers and Investment Bankers (KASIB) filed a suit against the taxman asking a court order to stop the implementation of Capital Gains Tax (CGT) by the Kenya Revenue Authority citing difficulties in implementation of the levy. The brokers whose revenue is largely determined by trading volumes of financial securities also argue that Capital Gains Tax (CGT) will stall activity in the bourse.

The weight of these allegations is now being felt in the Nairobi Securities Exchange as trading volumes on the month of January 2015 went down 35% as compared to the same period in 2014. Market activity level is a key tenet of technical analysis and hence depressed activity paints a grim picture of the capital market. This negatively affects both the NSE 20-share Index (NSE20) and the NSE All Share Index (NASI).

In the same period, foreign investor inflows have plummeted by about 50% as compared to a similar period in 2014.  This is an indication of slowing foreign investor activity in the bourse. Capital gains tax deters investments by foreigners which is a blow to the economy.

Due to several of these modalities, brokers had threatened to suspend the trading of securities for a whole month beginning on 20th February 2015 to 18th March 2015 when the High Court will announce its decision on a petition filed  KASIB against KRA on its proposed implementation of CGT. Such an action could have been severely detrimental to the East Africa's leading bourse.

This is the reason why the government really needs to rethink its decision to re-introduce Capital Gains Tax (CGT) after it was dropped in the mid 1980s as a way of encouraging local and international investors. I am of the opinion that tax naturally has the effect of scaring people and the government could still achieve its planned capital markets tax revenue targets through other means other than CGT.