Chinwendu Obienyi
Financial risk management is regarded as the process of identification, analysis and acceptance or mitigation of uncertainty on any financial investment decision.
This essentially means that it can occur when an investor or fund manager analyzes and attempts to quantify the potential for losses in an investment, such as a moral hazard, and then takes the appropriate action (or inaction) given his investment objectives and risk tolerance.
Therefore risk management is a key integral part of the financial system but the growth of any business or market expansion (development) can pose challenges to managing risk that could come up.
As a result, financial instruments have evolved over time, thus berthing financial derivatives, instruments that could manage risks.
According to reports, trading in derivatives has a 10,000-year-old history. In humanity’s financial history, derivatives have always had a place. From Babylonians to the medieval era to the current electronic age, derivatives have existed all this while.
Currently, many stock exchanges across the globe especially the Nigerian Stock Exchange (NSE) who are predominantly equity driven have taken to leverage on this product in order to hedge against risks or diversify market offerings.
According to Investopedia, derivative is contract between two or more parties whose value is based on an agreed-upon underlying financial asset, index or security. The underlying asset could be in form of a commodity, bond, foreign exchange rate, debt instruments and stocks.
There are two important functions which are played by financial derivatives namely hedging and speculation. Hedge instruments are used in an attempt tor reduce the risk level attached with underlying transactions by entering into derivative contract while speculation presumes the financial risk with the prediction of gain from market flunctuations.
Therefore, the efficient use of financial derivatives reduces risk level and increases rate of return while improving the financial health of business and climate. This goes to show that the main concern of any firm or market is to manage the risks in such a way that foster its operating activities and increase its return.
Thus, it is deemed necessary to introduce such instruments like the derivative in market to help achieve the desired objectives.
It is safe to say that regulatory authorities as well as operators have stepped up efforts to strengthen the Nigerian capital market and make it compete favourably with other exchanges across the globe.
Recently, the Securities and Exchange Commission (SEC) revealed that the rules on derivatives would be ready soon.
The Acting Director General of SEC, Mary Uduk, noted that the Commission had been building capacity in-house in partnership with South Korea for the development of derivatives.
“We have a knowledge sharing programme with them, they have been to the country twice now and our staff are scheduled to travel to their country for more training. Even their ambassador has been to the commission and all of that is part of building capacity and training the staffs.
Even in the market NSE is doing a lot in the area as well as the FMDQ who are taking some people to India this month on capacity building. All stakeholders including the CBN have been joining hands to ensure that we get it right,” she said.
Furthermore, SEC identified derivatives as one of the investable products that would enhance the liquidity of the Nigerian capital market.
Uduk stated this at the Final Reporting Workshop of the Knowledge Sharing Programme (KSP) recently in Lagos.
The KSP which centers on “Capacity Building on Operation and Development of Financial Derivatives Markets in Nigeria” is aimed at tapping from the Korea’s expertise and excellence towards developing the derivatives market in Nigeria.
According to Uduk, there is no doubt that the KSP has presented a good opportunity for addressing some of the market’s challenges in setting up a strong and functioning derivatives market, especially in terms of having the required market infrastructure, regulatory framework and surveillance system for the derivatives market in Nigeria which are the target areas of research.
The NSE on the other hand has partnered JP Morgan Chase to facilitate in-depth capacity building programme on derivatives market.
According to a statement dated August 22, 2019, the collaboration with JP Morgan is expected to promote the development of derivatives in Nigeria by helping to bridge the knowledge gap on derivatives investments and trading strategies through knowledge transfer.
For his part, the Managing Director of United Capital Securities, Jude Chiemeka, said in terms of product development, derivatives would help enhance the array of services that the brokerage communities are currently enjoying.
He said: “Derivatives is derived from other things that exist in the economy. First of all, in terms of product development, it would help enhance the array of services that the brokerage communities are currently enjoying.