Interview: Tapas Das
What is your assessment of capital markets amid the launch of exchange-traded derivatives (ETDs) on the Nigerian Exchange?
TAPAS DAS: Nigeria’s capital markets were primarily client identification-based, whereby trades were executed on the client level. In contrast, the omnibus model used by Western counterparts permits managed trades of more than one person by a broker and allows for anonymity of the individuals in the account. All trades had to be settled in the Nigerian markets and there was no instrument that allowed participants to hedge the price risk of their portfolio. The launch of ETDs, which are traded on a regulated exchange, affords participants the opportunity to hedge their portfolio and benefit from standardisation, liquidity and the elimination of default risk. The implementation of a CCP model is a prerequisite to the launch of ETDs since it serves to take on credit risk, and clear and settle transactions. Moreover, it underscores the responsible maturing of Nigeria’s capital markets and aligns them with international best practices.
In what way is the CCP model different from the existing settlement system used in Nigerian capital markets and what are its benefits?
DAS: Currently, in the cash equity market all orders are pre-funded and settlement is bilateral. The CCP model differs by interposing between the two parties – that is a buyer to the seller and a seller to the buyer. This eliminates the requirement of the participants to manage counterparty risks individually. This way, the entire credit risk of your counterparty is assumed by the CCP, ensuring a very high degree of safety for the market. The additional benefit stems from the concept of netting. Current bilateral settlement results in one-to-one movement of securities resulting in a significant number of movements increasing operational risk and cost. However, by employing the process of multilateral netting through the CCP model, a high degree of efficiency can be achieved– reducing transaction risk and cost.
To what extent does a CCP guarantee trades between counterparties?
DAS: To ensure timely and guaranteed settlement, a CCP collects an upfront amount, termed the initial margin, to cover the worst possible loss – that is, the prepayment of anticipated losses to mitigate the risk of default on settlement day. This is complemented by monitoring contracts on a real-time basis to ensure any extraordinary movement is captured and special calls for funds can be made based on such situations. A powerful auxiliary mechanism is marking the traded price with the current price to determine the profit or loss incurred at any given point in time. These amounts are settled at least once a day under a procedure called mark-to-market margin. Furthermore, there is a dedicated corpus for default called the Settlement Guarantee Fund, which can be invoked based on need. CCPs engage in frequent backtesting and conduct a series of periodic stress tests where the margin parameters are modulated to satisfy enhanced stressed scenarios.
How important is continuous education and training to deepening the derivatives market?
DAS: The value proposition of the derivatives market is broad, but there is a need for training and education about the complexities, risks and benefits involved. This process can be facilitated by leveraging technologies such as financial e-learning tools and capitalizing on foreign partnerships to foster knowledge and skills transfer given the interconnectedness of global financial markets. Furthermore, training must be practical and equip investors with the tools to make informed investment decisions. The broader objective of public awareness is to catalyse inclusive growth by democratising access to financial markets.
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