The objective of organised stock exchanges around the world is to provide liquidity which is the lifeblood of financial markets.
When the liquidity is high, more investors participate in the stock market and are ready to invest in assets of different risk classes. This is one reason a number of IPOs are floated in the market when the liquidity is high.
Currently, less than 30 per cent of listed equities are actively traded, while the Nigerian Stock Exchange (NSE) offers only basic products and in a bid to deepen the stock market, the nation’s bourse at its 2018 Annual General Meeting (AGM) recently, revealed that it was set to introduce the already heralded Exchange Traded Derivatives (ETDs) in the second half of 2018.
An exchange traded derivative is a financial instrument that trades on a regulated exchange and whose value is based on the value of another asset. They are derivatives that are traded in a regulated fashion and have become increasingly popular because of the advantages they have over over-the- counter (OTC) derivatives, such as standardization, liquidity and elimination of default risk.
It would be recalled that while the NSE was concluding arrangements to introduce the ETDs in 2017, its counterpart, Hanoi Stock Exchange (HSE) ,Vietnam, officially launched its derivatives market with stock futures contracts the first, to begin trading.
According to the HSE, “Derivatives trading was planned several years ago to help draw more investment to Vietnam’s capital markets and broaden the country’s finance industry.
The futures market would initially launch stock index contracts, and when fully operational, more instruments would be introduced and the launch will help attract more foreign investors, institutional investors in particular, and boost market liquidity.” While speaking recently at the NSE’s 57th AGM in Lagos, President, National Council of the Exchange, Abimbola Ogunbanjo revealed that the Exchange has made significant progress in its efforts to establish the first Exchange ETDs market in West Africa as it has achieved a number
of major milestones during the year. These according to him, include successful articulation of enhancements to legal and regulatory frameworks supportive of derivative instruments; drafting of a comprehensive Rulebook and exposure of same to the market and completion of development work on
enhancements to our trading engine. Others include delivery of training programmes tailored to the needs of the variety of professionals across the entire derivatives value chain; widespread stakeholder sensitization efforts to enhance prospective participants’ capacity and awareness; and the development of requisite specifications, pricing, and liquidity enhancement frameworks for the maiden ETDs.
He further said, “We have deployed a new four year corporate strategy that will reposition us as a more investor friendly and customer centric exchange hub in Africa. With this new strategy, we are poised to deliver superior performance for our multifaceted stakeholders especially issuers and investors who continue to access our market to raise and save capital respectively.” According to Ogunbanjo, derivatives are simple tools that allow market participants to efficiently manage their risks and it was this initiative that helped South Africa’s capital inflow and market participants to price, unbundle and transfer risks.
“Its market comprises two broad categories, namely: options and futures. Within these two categories, a wide range of instruments may be identified: warrants, equity futures and options and other instruments are the agricultural commodity futures and options, interest rate futures and options, currency futures and fixed income derivatives.”
“Accordingly, as innovation drives interest in any product, the market will require continuous advancement to risk frameworks, technology and critical thinking to bring about competition which is a basic driver toward development and growth in the market”, he explained.
Corroborating, Chief Executive Officer, NSE, Oscar Onyema revealed that the launching of the ETDs later in the year will not only help the Exchange meet its objective of facilitating order
flow across various asset classes; but will offer its ever-increasing community of domestic and global investors a greater array of products to diversify and manage risk. “The Exchange has begun to see gains from monetizing the market services and it has the capacity to support exchange hosting services to Exchanges within Nigeria and the rest of Africa, and continues to increase revenues from market data sales via new opportunities”, he noted.
The question striking the thoughts of the investing public is how much of impact can be generated via the introduction of the ETDs in the capital market especially as it is developing.
Exchange traded derivatives are well suited for the retail investor, unlike their over-the-counter cousins. In the OTC market, it is easy to get lost in the complexity of the instrument and the exact nature of what is being traded. In that regard, exchange traded derivatives have two big advantages:
•Standardisation: The exchange has standardized terms and specifications for each derivative contract, making it easy for the investor to determine how many contracts can be bought or sold. Each individual contract is also of a size that is not daunting for the small investor.
•Elimination of default risk: The derivatives exchange itself acts as the counterparty for each transaction involving an exchange traded derivative, effectively becoming the seller for every buyer, and the buyer for every seller. This eliminates the risk that the counterparty to the derivative transac- tion may default on its obligations
Another defining characteristic of exchange traded derivatives is their mark-to-market feature, wherein gains and losses on every derivative contract are calculated on a daily basis. If the client has incurred losses that have eroded the margin put up, he or she will have to replenish the required capital in a timely manner or risk the derivative position being sold off by the firm. In addition to its potential to generate income, the instrument can serve as hedge against certain exposures in the market and will create an alternative investment outlet for those who can assume risks that are greater than normal.