Factors hindering derivatives trading at the Nairobi Stock Exchange

Abstract

As from early 2000s, the Nairobi Stock Exchange (NSE) and the market regulator Capital Markets Authority (CMA) endeavored to reform the market. As part of the market reforms agenda, the Authority initiated market reforms in 2001 which led to the reorganization of the NSE into four distinct segments: the Main Investments Market Segment (MIMS); Alternative Investments Market Segment (AIMS); Fixed Income Securities Market Segment (FISMS); and the Futures and Options Market Segment (FOMS). To date all but the FOMS remain active. The derivatives market in Africa and specifically the NSE remains underdeveloped. One of the major hindrances to the derivatives market development, which is the focus of this paper, is the regulatory and policy environment. There is need to develop these so as to provide a framework within which the market can operate effectively and efficiently. Other disabling factors to the development of the derivatives market discussed in this paper includes; the level of investor sophistication and awareness is low; lack of commodities on large scale; high frictional costs in the market structure; inadequate risk management; inadequate liquidity; and segmented regulation. The study further explores the efforts being done by the NSE and the CMA towards the development of the market. This includes the findings of the study undertaken by the CMA on the viability of establishing a futures and options market segment at the NSE. To help understand the factors hindering derivatives market development; in this concept paper, I have explained key concepts relating to derivatives market development and the various types of derivatives. The benefits and uses of derivatives and their down side/ disadvantages have also been highlighted, drawing from real life experiences across the globe. An overview of studies on derivatives and derivative markets in Latin America, India, South Africa, Asia and Kenya has been discussed.