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.