All ducks now appear to be in a row for the launch of Exchange Traded Derivatives (ETDs) in the Nigerian capital market. This comes on the back of the official launch of NG Clearing as Central Counterparty (CCP) Clearing House in Nigeria on Thursday, 9 December 2021.
Speaking at the event, the Chief Executive Officer, Nigerian Exchange Limited (NGX), Mr. Temi Popoola, CFA, stated, “I am excited to witness the official launch of NG Clearing and must congratulate its Board and Management for this historic milestone. As a multi-asset Exchange, NGX recognises the importance of a well-developed Derivatives market, and we have worked hard to put the right regulatory and technology framework in place to support the launch of a standardized Exchange Traded Derivatives (ETDs) market. Our efforts will be further supported by NG Clearing, the best in class CCP and Clearing House. These are indeed exciting times for the Nigerian capital market and I am excited about the prospect of deepening Africa’s position in the global financial market with the imminent launch of ETDs.”
The activities of NGX in establishing a vibrant Derivatives market have also focused heavily on capacity building. Being the first line of contact for investors in the capital market, NGX has reiterated that it is imperative that participants who engage in the derivatives business have adequate knowledge of these instruments. As such, The Exchange has organised workshops, webinar and conferences the most recent of which was the 2021 Market Data Workshop with the theme, “How Market Data Powers Investment Strategies Using Derivatives Products.”
Taking a cue from NGX, perhaps it would be important to establish the right foundation in explaining what Derivatives are and some of the key elements that are required to successfully trade this asset class. Derivatives are financial instruments most popularly used to reduce or hedge risks, and are also believed to cover downside risks when large exposure exists in a portfolio long on stocks. Among the different commonly used financial instruments, index derivatives have raised a great deal of attention in researchers around the world.
Index derivatives exist for all asset classes, and over time their use has grown exponentially for a variety of purposes. The ability to leverage by investing a small amount to gain exposure to a much larger investment is the key benefit of index derivatives. While index futures have a symmetric impact on portfolio returns, index options can have an asymmetric impact. That said, both are valuable, cost efficient tools for a number of reasons for a portfolio manager.
For example, if an investor has shorted a large number of single securities, a single index call option can provide a great hedge against an inverse-market move. However, if an investor has large cash holdings that he or she wants to use for buying stocks after further research, a quick and easy way to deploy the funds is to go long on an index futures contract. This provides the exposure the investor is ultimately looking to gain, buys time to do the research, costs far less and manages the price impact of large trading in a short time frame. Small purchases over time reduce the effect over prices and will not create a market impact.
Similarly, when a large number of securities need to be sold off, buying an index futures gives time to ease in the selling over time and dampen price pressure. As cash positions are built over time, the index future maintains the overall security exposure until further investment decisions are made. This approach makes sense for both active and passive investors, where large trades can be counterbalanced with the use of index futures or options bought at a low cost by an investor to avoid having large price-impacting shifts in exposure.
Reports from NGX have shown that upon the introduction of ETDs in the market, index futures will be rolled out in the first year, while other products will follow as the market evolves in line with market readiness and demand. It would be recalled that NGX recently received approval for seven derivatives contracts from the SEC including the Access Bank Plc Stock Futures, Dangote Cement Plc Stock Futures, Guaranty Trust Bank Plc Stock Futures, MTN Nigeria Communications Plc Stock Futures, Zenith Bank Plc Stock Futures, NGX 30 Index Futures and NGX Pension Index Futures.
Ultimately, the Derivatives market is expected to complement existing cash markets and provide investors and other market players with the necessary tools for tactical asset allocation, risk management and cost management for effective portfolio management. It will, therefore, be interesting to see how the market responds once ETDs are introduced in the near term.