This paper examines the role of derivatives in South Africa. It provides an overview of the derivatives market in South Africa and discusses options for promoting the development of derivatives markets in Sub-Saharan Africa. Derivatives markets can facilitate the management of financial risk exposure, since they allow investors to unbundle and transfer financial risk. In principle, such markets could contribute to a more efficient allocation of capital and cross-border capital flow, create more opportunities for diversification of portfolios, facilitate risk transfer, price discovery, and more public information (Tsetsekos and Varangis, 1997; Ilyina, 2004).

South Africa’s derivatives market was established to further develop the financial system, enhance liquidity, manage risk, and meet the challenges of globalization. However, like other emerging derivatives markets, the development of South Africa’s derivatives market—the only one in Sub-Saharan Africa (SSA)—stemmed primarily from the need to “self-insure” against volatile capital flows and manage financial risk associated with the high volatility of asset prices.

The market comprises two broad categories of derivatives, namely options and futures. Within these two categories a wide range of instruments may be identified: warrants, equity futures and options, the agricultural commodity futures and options, interest rate futures and options, currency futures and fixed income derivatives. The fixed income derivatives are made up of bond futures, forward rate agreements (FRAs), vanilla swaps, and standard bond options.

South Africa’s derivatives market has grown rapidly in recent years. While this has supported capital inflows and helped market participants to price, unbundle and transfer risk, the risks associated with its misuse have also increased. There are many derivative instruments traded with different institutional arrangements on the OTC markets and regulated exchanges. There are also tight regulations on asset allocations by insurance and pension funds to prevent excessive risk taking. Such regulations can constrain the potential benefits that they could bring to the local derivatives market. While the misuse of derivatives can lead to a financial crisis, accelerate capital outflows, and amplify volatility, their advantages should not be discounted.

SSA countries can explore the possibility of regional cooperation in derivatives market listings. Small SSA countries with a nascent local securities market would derive particular benefit from listing and trading their derivative instruments on a regional derivatives market. The rest of the paper is structured as follows. Section II presents the background to the derivatives market in South Africa. Section III describes the current state of the market, while section IV presents the current issues affecting the future of the market. This is followed in Section V by a discussion of policy lessons for countries of Sub-Saharan Africa from South Africa’s experience.

Contents

I. Introduction
II. Background
III. Current State of the Market
IV. Current Issues Affecting the Future of the Market
V. Lessons for Countries of Sub-Saharan Africa from South Africa’s Experience
VI. Conclusion
References

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