The Derivative Markets in Zimbabwe - Policy Recommendations, Implications and Conclusion

POLICY RECOMMENDATIONS, IMPLICATIONS AND CONCLUSION

5.1 Introduction

Derivative trading is growing phenomenally and it is not exceptional in the Zimbabwean case. Based on findings, the derivative market in Zimbabwe is still small but growing at a very much faster rate. The market now stands at above Z$1 billion in size. In reality, derivatives can be dangerous to the economy in general as already indicated under empirical review section in Chapter 2, but considering the rate at which they are growing the world over, it is not wise to talk of eliminating them now. What is rational now is to make sure that they became relevant to our economy

Zimbabwe cannot live in isolation, the world is fast becoming a single global village and we are institutionally forced to dance according to this tune. For as long as other nations are trading these products, Zimbabwe must also do so. Despite bad stories and experiences attributed to derivative trading, derivatives cannot be eliminated. Empirical evidence relating to bad news about derivatives shows that the derivatives are not to blame but rather ignorance and loose regulatory framework to monitor and govern the markets. Speculative trading is the major culprit in most cases.

In the Zimbabwean case, the researcher established that many companies are exposed to huge market risks in form of exchange rates, change in commodity prices, interest rates, change in stock prices and default risk. Profitability, viability , efficiency and competitiveness of many such companies are not stable even in the short run. If the situation continues unabated, corporations may face severe viability problems in the long run. Responsible authorities should take the initiative to avoid such feasible disasters. In most financial statements released for the year ended 31 December 2003, many companies incurred exorbitant interest expenses because of high lending rates (about 800 percent) which prevailed in the last quarter of year 2003. Non-Performing-Loans (NPLs) for most banks also ballooned because of the downgrading of borrowers.

5.2 Policy Recommendations and Implications

Over and above, derivatives are necessary hedging instruments but should not be traded for the sack of trading. In Zimbabwe, in as much as derivatives are highly necessary, a lot still have to done. It is to the advantage of stakeholders that derivatives in Zimbabwe are still young and a strong regulatory foundation can be laid down to avoid crisis management like the one currently exercised in the financial sector. The erratic trading of derivative products is a worrisome situation which should be tackled to make sure that the economy benefit from these products. It is fundamental to acknowledge that major players in the derivative market are bankers and instability in the financial sector can be detrimental to the whole economy. The researcher suggests that it is not advisable to eliminate derivatives but rather facilitate transparent and safe trading. For our economy to benefit from derivatives we should make sure that they are used as hedging tools and nothing else. To achieve this, the researcher recommends the following policies:

* Regulatory framework must be in place to govern the market. The recently established Derivatives Dealers Association has to do a lot to regularize the trading of derivatives. The association must work hand in gloves with the Zimbabwe Stock Exchange. They is still a lot of irregular trading on the cash markets especially the stock exchange and this must be ironed out first.

* Like in foreign currency trading where banks are given licenses to deal with forex, the same must be done with derivative trading. Underwriters of Over-The-Counter derivatives must be given licenses by the Reserve Bank of Zimbabwe and this enhances effective monitoring of derivative markets. Many derivative underwriters tend to overtrade thereby exposing themselves to liquidity problems. Based on on-site assessment and off-site assessment, the Central Bank should only give licenses to those institutions which have strong liquidity, strong capital position and qualified personnel especially giant insurance and asset management companies.

* The Central Bank in conjunction with the Derivative Association Committee should monitor the size of derivative portfolio of each and every licensed underwriter. This must be done regularly and more oftenly since most dealers can be tempted to underwrite unmanageable derivative portfolios. This is risky to the underwriter and the economy in general because of the interconnectedness of economic sectors. The break of ENG Capital is a typical testimony of the effects of a break of a financial institution to other economic sectors.

* The Derivative Association which must comprise of derivative technocrats with vasity intuitive derivative understanding must impart derivative awareness. As already indicated in Chapter 4, many corporations have no understanding of derivatives and their importance to business viability. The growth of trading must be in tandem with understanding to avoid ill-informed decisions. Both underwriters and endusers must be well-vexed with the models and risk measuring methodologies. Derivative Association should facilitate the importation of derivative software.

* The off-balance sheet nature of derivatives have been blamed for speculative trading which has significant destabilizing potential. To this effect, endusers and underwriters must disclose their trading of derivatives. By auditing derivative books of participants, the Reserve Bank of Zimbabwe and Zimbabwe Stock Exchange must be able to identify firms trading derivatives so that they can enforce them to disclose.

* Exchange markets must be established. The government must move towards the establishment of futures exchange to harness forex liquidity. Companies are badly exposed to risk particularly those engaged in international trade. This move must compliment future plans to have free-floating exchange regime.

* Lack of confidence by investors is another factor identified as a cause for willingness to trade derivatives by most potential endusers. To this effect , the researcher recommends that the monetary authorities must enforce credit rating of all listed financial institutions involved in derivative underwriting. Credible credit rating system must be effected through credible credit rating companies like Global Credit Rating Company (GCRC), Credit Rating Company Duff (CRCD) and Phelps Credit Rating Company Africa).

* The complexity of derivatives is beyond comprehension by most small and medium companies. The establishment of infrastructure to safely and effectively trade derivatives is costly which also is beyond adequate financing. The