On October 3rd, 2014 the Kwacha, The Nigerian Naira, Kenyan Shilling and the Zambian Kwacha Friday made their début on the Johannesburg Stock Exchange (JSE), the largest and most liquid exchange in Africa. A move regarded as a Milestone by Government and the media alike. However, there seems to be a lot of confusion among Zambians about what this really means. So we answer some frequently asked questions behind this initiative and dispel some myths along the way.
The Zambian Kwacha started trading on the JSE on Friday
What is actually being traded?
The forex market on the JSE is not a currency bureau, where people can buy and sell the Kwacha. This is a futures market, where investors and businesses that import or export can buy Currency Options or Currency futures, which belong to the derivatives market.
- A Currency Option (CO) is a contract that gives the investor, the right, but not the obligation, to buy or sell a currency on a future date at a fixed price. A variation of a currency option is called a Put Option, that gives the investor a right to sell a currency at a future date at a particular price.
- A Currency Futures (CFs) Contract is an agreement that gives the investor the right to buy or sell an underlying currency at a fixed exchange rate at a specified date in the future.
These instruments are primarily used as hedging mechanism to protect investors and businesses from the adverse effects of currency fluctuations. “The message is simply: hedge your foreign exchange risk on the JSE and go and do your business,” according to Andrew Gillespie, head of futures at Tradition Futures, which partnered with the JSE and Barclays bank to launch the platform.
Is the Zambian currency now being held as a reserve in South Africa?
The Zambian currency will not actually be held in South Africa or on the exchange. This is a derivative, which is a special type of contract that derives its value from the performance of an underlying entity. In this case that underlying entity is the future value of the kwacha that is being traded. Therefore all contracts are based off the value of the kwacha, but the kwacha is never actually held, so the kwacha will not all of a sudden appreciate because of a new demand for kwacha caused by the JSE. In fact the contracts are cash settled in Rands and no physical delivery of the foreign currency ever takes place. So if a Zambian importer buys a currency option on the JSE and the kwacha declines in value, making their imports more expensive, that importer will be compensated the difference in value in Rands.
Why Zambia, why Africa?
The parties behind this initiative include the JSE, Barclay’s Africa and Tradition Futures, A Swiss financial company that is one of the world’s largest interdealer brokerage firms (A company that facilitates transactions between financial institutions). Strategically, this is a pilot initiative, therefore three countries from each region (except North Africa) needed to be selected, Nigeria and Kenya are the economic powerhouses in their respective region, while Zambia has boasted stellar economic growth over the years and has become one of the leading destinations for South Africa’s exports, not to mention the number of South African retailers trading in kwacha, but need to repatriate their profits in Rands back to their home country. There are many pundits that feel, that Africa is the next big emerging market and this is a strategic step by two huge financial powerhouses in Barclays and Tradition Futures to further position themselves in the African financial market and a move by the JSE to increase its visibility to the international capital markets. Therefore if these initial 3 listings are considered a success, more African currencies will follow.
Who make Money on this initiative?
There are three parties involved in these types of transactions:
- The party buying the instrument- which are usually investors, which is a very broad definition, but the bulk will be financial institutions, and businesses (small and large) that import and export in Kwacha. Most large businesses have entire finance departments that work on currency hedging.
- The JSE, which earns fees from listing the currency
- The Counterparty, which again is the JSE (though it would be no surprise if there are other parties involved behind the scenes). The counterparty is the party offering the contract and receiving the fee from the party buying the instrument. Think of the counterparty as the Insurance Company, they take premiums and if need be they are the parties responsible for paying the loss should one occur.
How will this help the Zambian Economy?
Directly, this will not help the Zambian economy as this will be mainly utilized by businesses and investors for their hedging purposes.
Indirectly they may be some benefits to the Zambian economy; one such area, is it may help provide additional confidence to investors making investments into Zambian money markets. For example, there are many institutional investors that like the interest rates of Zambian treasury bills (north of 20% over the last few months), but will not make the investment because of the currency risk associated with the investment. That is why we have seen over the last few months, the Bank of Zambia Treasury auctions being heavily under-subscribed, but the Eurobonds in U.S dollar being oversubscribed. Now that the currency can be hedged, you may see these types of investors consider investing in Zambia.
However there are still some variables that will impact their investment decision like the price of the contract. Without getting into the complex details of how derivatives are priced, the simplest manner will be to think of the kwacha as one unit, the premium paid is then a percentage of that unit. If that percentage is 10%, then investing in the Zambian money market becomes less attractive because 10% of your 20% yield is going towards hedging the currency. As the volatility of the currency increases or decreases, the price is adjusted accordingly to ensure the counter party is making money.
The durations of the contracts are 3 months to 12 months, so this will have very little bearing on the decision to place Foreign Direct Investment into Zambia, where capital project into roads and manufacturing plants, for example, take years.
Will this lead to speculation that can hurt the Zambian Kwacha?
There are forex markets are all over the world and you always have speculators who use CFs to make a profit on short-term movements in currency prices and Arbitrageurs who use them to profit from the price differentials of similar products in different markets. So you will see speculations against the Zambian kwacha occurring and this type of market allows speculators to amplify their bets, as they can be done without actually needing to have the kwacha on hand (a term called leverage). While, intentional sabotage of the Zambian kwacha to make profits on the JSE is possible, it is highly unlikely especially over a long period of time, because of the number of complex mechanisms that would need to occur, not to mention, the more volatility in the kwacha, the higher the premiums will become or the counterparty will stop selling the kwacha contracts all together, because for every party that makes a profit, there is another party taking a loss. In an open market, products and prices always correct themselves to meet the appropriate levels of supply and demand.
By Mawano Kambeu
This is a joke right?
I didn’t pay attention to Kwacha trading outside of Zambia but if this is true it shows the power and strength of what Mr sata has done for this country
He is doing things never done before, like this.
How he has never been honoured by the Universities n zambia for a PhD in Politics is beyond me
Dr Michael Sata sounds plausible for me
Thanks
Quite frankly some people, in spite of their popularity and common feature on LT blogger ship circuit, still mistake it for social or such si.lly networking sites. The importance of logical discussions has not sunk in yet and I wonder why? Get a grip!
Sorry I actually meant ‘popularity’ and not popularity.
First of all, I would like to applaud the Author for shading more light on this very important business matter on behalf of the smart people of the Zambian Enterprise. But I want to reiterate that the Author left out some very pertinent issues that require immediate Bank of Zambia involvement here.
1. Contract Futures and Options are primarily hedging derivatives and this allows exports to hedge the exit price for their commodities out of Zambia at a contract strike price. For instance, over $6 billion in copper exports occurred last year alone. An exporter such as Glencore, may choose to short or put a contract at a lower ZMK rate today to be paid at maturity 12 months from today.
If that contract is executed, a settlement is expected on maturity at that rate.
2. Institutional Investors such as banks, hedge funds, thrifts such as pension funds and others holding these derivatives as marketable securities have highly complex computer algorithms that can anticipate trending patterns of ZMK based on fundamental, technical and sentimental analysis.
These are the main drivers when it comes to price movement and can artificially influence the exchange rate at any given time. There are other items too detailed for this audience that I can delve into but I would be wasting my time because of the complex nature of these financial derivatives and the scope of these discussions.
As a result, Bank of Zambia needs a division to monitor these activities to make sure there is compliance not only with settlements but also to avoid insider trading.
3. Contract Futures and Options also work with derivative swaps. Some work with spot pricing while others work with market pricing. The complexity of these pricing mechanisms allow for transfer pricing to occur. For those not conversant with the term transfer pricing, in layman terms it means a company’s ability to use its own subsidiaries to conduct business from a higher tax jurisdiction to a lower tax jurisdiction.
For example, Glencore may use swaps for these derivatives to hedge their future price at which they would receive their payments from a subsidiary on the other side buying the same contract that Glencore is putting on one side, and it shorts on the other side.
The transaction would be complete but tax evasion just occurred, BoZ would follow the money and catch this.
4. Contract Futures, Options and Swaps do not limit these derivatives from participation in spot trades and speculators like this. Because these derivatives use what is called the zero sum theory, to every profit made on one side, a loss occurs on the other side but the intermediary brokers on the exchange always win because for every contract executed a commission is paid. It could be as low as $0.90 per contract such as as those paid on NADEX but the brokers also collect a spread.
So, you have a contract fee on every transaction and a spread is paid by both the seller of a contract and the buyer of the said contract. Bank of Zambia needs to have skin in the games so that they share in those in this $3.2 trillion a day volume business after all settlements would involve them.
5. Even though this is not really the final part I just happen not to be interested in keeping writing and writing, Barclays Bank, Tradition Futures and JSE are always going to be winners as explained above and therefore have a profit motive but Bank of Zambia has both.
A profit motive and a regulatory responsibility as fiduciaries to the smart people of the Zambian Enterprise. It is important to note that all micro and macro economic factors show that, Zambia is on an upward trajectory therefore this listing is not for nothing.
It has real implications for our currency and economy but like everything good in life, special attention is required in keeping things under control and making sure the platform benefits us and not brokers alone.
Mr mawano kambeu.. you should have sent this article directly to Sata`s bedside,,,,,,,, i myself, i have already sent a copy to my president ,,, president mpombo who is on working holiday, he is analysing it
This is a simple and concise explanation, than some ranting I encountered on the other posts
Its not puring a hedging initiative, I know the JSE is by far the largest exchange in Africa with total capitalisation of above $929B comparing to cairo and largos with above 400 listed companies in difference interest sectors lagest of them Financial services with great linkages and innovations amongst the asset classes and hedging instruments being trade with wide impact on other in a typical put call parity theorem
JSE as one of the exchanges I have studied offers trading of variety of derivates futures,bonds,options on equity ,currencies, interest rates including commodities in a well balanced modern portfolio thinking
What do you see when you review and look at the JSE all share index
Good analysis mawano,but you were supposed to add shipping credentials,mawano also manages a shipping company between USA and Zambia
May God continue to bless Zambia!!
We only hope our luse can replicate the financial sophistication of JSE to tap in financial resources in the most innovative and fluid way at cheap costs and rally behind JSE to have forward and back ward linkages especially as an emerging investments platform
Lets change the narrow thinking when we look at the assets and turn the clock 360 degrees and see what we can see from the JSE listing of the kwacha.
There will be increased positions in the Kwacha as the currency of trading and many investors may choose cash delivery to close and meet their kwacha obligation and visa versa as opposed to the USD/ZAR and investments bankers and counter parties in Zambia affecting the Kwacha
Then you trade the underlaying in that asset in currency that underlaying can be an alternative ,equity as in shares ,fixed as in bonds or even commodity all with correlation and covariance’s giving you a weighted return as a careful well informed trader or investor
All else is summarised by the currency indirectly or directly traded or hedged The currency is worthless except the above underlaying
Its therefore a plus for the kwacha why hold junky instruments in a currency with weak fundamentals or underlaying
lets work the kwacha and support the region before we think afar
@Jonathanmhango Financial Analyst, u sound drunk am i right or maybe u just have an idea & dont really know what u talking about?
Yahaa
So you think a currency?? is the under laying Its the derived asset in it
Iwe Jona? uleichindika waumfwa? learn to write comprehensible stuff, not this mumble jumble sentences with no full stops , commas or flow of order. I know you are a ZICA graduate but please quite this nonsense or better of go and take a communication skills class!
Ba Tekere Banda, I ‘m glad you have also noticed that this man calling himself JonathanMhangoFinancial Analyst at the very least sounds drunk. I have noticed since time immemorial that in trying to sound intelligent he copies and pastes stuff from sources he does not even acknowledge but ultimately the things he says do not make sense – it is always just rambling. Personally I work in financial services and if what he says does not make sense what more to the layman? Keep it simple ba so called JonathanMhango Financial Analyst. There is absolutely no need to keep copying and pasting things that end up being totally incomprehensible to the reader. Just saying….
Mawano, Well done! Lusaka times, well done. You are quite objective and those of us who are rational always read your online posting to get some objective reporting! It is disappointing that people like Mushota comment on anything even when they are ignorant about an issue. They expose their ignorance!
My take is that whether we like it or not, Zambia is still considered as good investment destination as the fundamentals are still sound despite the damage done in terms of policy inconsistency,lack of policy direction, fiscal irresponsibility, big government, ranting by politicians without knowing implications on investor confidence etc since 2011. Bloggers, please avoid commenting if you are ignorant about the subjects! Let experts handle technical stuff so that we learn.
Yaa I see there is delivery by cash settlement which is much more practical also learn and see how its done by UBS Warburg Deutche Bank JP Morgan chase citi bank and other
You basically have contracts whose underlaying can be an asset like an equity bond or alternative shorting and going long when you read the market well Its simply not the currency alone but the assets that people with vested business interests will need to move around various asset classes
In short the kwacha listing opens the Gap into these other asset classes on the JSE bring into light the classic investments tactics such
There is no need to be simple We can teach you as we share A up to…
Incorrigible gibberations from one Jonathanmhango financial analyst.
Now coming to the Mushota’s of this world who are commending our Kwacha being listed outside Zambia. My advice to you is just to STFU because I do not think you even have an idea what is going on. Ultimately the beneficiary is the South African economy because that is where the fees and commissions are going to be earned. It is not the Zambian that is going to be employed but the South African national. We have a functioning stock exchange since 1994 in Zambia. If these investors are really interested in developing our capital market they would be talking to our SEC to help set up the regulatory framework for the trading of our currency locally. Why are you afraid to set up shop in Lusaka but you would rather do it in J’burg using our currency? This is total nonsense.
Your analysis is admirable
Well done
Thanks
With due respect to mawano kabambeu his write up above should be thorough bring the whole meat on the cons and pros of the kwacha listing on JSE
As to my friend HH learn to be sober and diject the meat and see through the whole allay of investments products and initiates that will come thru with the listing of the kwacha
Even my lover at JSE was laughing at your comments as lacking understanding of the whole opportunity and picture If I teach her the trades and strategies at JSE listed what more you
Call me on 0977431296 will discuss networking and learning including the Africa investments forum you need to participate in and see
Financial analyst why giving out your number, maybe Mushota can call you,this doesn’t need any discussing or complicated theories just the fact that only 2 other countries are doing it should be a sign that it’s not all roses otherwise everyone would have jumped on the bandwagon,
JSE is a world recognized stock market. Using JSE as platform is a good step for Zambia. LSE and JSE are have been partners since 2004. The Zambian stock market is poised to grow but there is need to diversify the LSE from stocks trading to cover other trades such as futures, options, municipal bonds, government bonds etc. Financial Sector is well managed so far by BOZ but deserve more players to come on board that brings completion and thus attract more institutional investors and brokers and agents.
B r Mumba sr,at JSE can you profit and mark to market with technical or sentimental analysis in trading looking at the effectiveness and efficiency in analysts and traders well experienced
Your margin losses will b very magnified I like and read the other points with interest but though have followed the derivative exchange here developing ,there must be equal to this initiative
Please also under stand that Chief Investments officers don’t simply lock in the derivatives as they trade their traditional assets they will go long and short accord lying assets in which they feel they can benefit some profits before closing their positions
Holding Maturity investors few…
Investing in non Domestic Equity securities at luse might be upped assuming that luse moves fast to road show with depository receipts being made simple assuming that the entrench of the kwacha is cemented to give confidence to trade on luse listed securities
Its like you have the Kwacha with a Gold standards and options are being traded with the underlying being gold with correlation to other asset classes like equities bonds and other moving position to seek some superior profit
Look at the listing in its entireness not simply options There will be increased usefulness for the kwacha as a result extending the market trades for asset classes being traded on luse innovatively
Look at it in its entirety and relate the listing of the kwacha to the whole universe
Trading & Products
Bonds
Bond Derivatives
Debt EM
Equities
Exchange Traded Products
Kruger rands
Warrants
Derivatives with replication
Agricultural Derivatives
Currency Derivatives
Energy Derivatives
Equity Derivatives
Interest Rate Derivatives
Metal Derivatives
Learn also something about mark making by market makers below and see what is more to it than simply derivatives Very soon there could be massive investing into local entities by south Africa companies as a result in cross trades with luse
ABSA Capital
Investec Bank Ltd
Nedbank Ltd
Rand Merchant Bank, a Division of FirstRand Bank…
Yaba iwe financial fimo fimo blaaa blaaa blaaaa ekutila shani? Tatulefibelenga iyo.Why is the kwacha already falling against the dollar.Was there overprotection?