Derivative Markets in the UAE - Report Example

Financial Institutions and Markets Derivative Markets Name of Student: Student No: Date: Name of Supervisor: Contents Contents 2 Introduction 3 Derivative Markets in the UAE 3 Definition 3 Participants 4 Futures 5 Options 12 Regulation of Derivative Market 13 Commodities Listed in the Derivative Market of UAE 14 Conclusion 14 References 15 Introduction The new millennium has brought with it new opportunities and much change in societies in general and their derivatives and securities market in particular. Where there are opportunities though, there also exist dangers. The repeated decline that financial market prices have experienced recently around the world illustrate the volatility of derivative and securities markets but also how conjoined the various economies are to each other. It is in fact said that there are very few things that illustrate uncertainty better than security prices (Korn and Korn, 2000). Many people are increasingly keeping track of the real time performance of asset markets on the whole and more particularly, their own portfolios. This is illustrated by the rise of individuals who indulge in day trade as a living, the proliferation and success of news channels dedicated to finance and the range of real time financial market quotations found online. Financial markets avail the opportunity to attain financial freedom, gamble, get an education, investment, power, security, the chance to participate or spectate a sport as well as vicarious or actual pleasure (Furnham and Arqyle, 1998). Derivative Markets in the UAE Definition Derivatives are defined as financial contracts with a value connected to the basic product, asset, charge, alphabetical listing or the happenstance or size of an event. The word derivative is the result of the process by which price of contracts is derived from the price of an underlying product, security or index or else the size of the event. A derivative is a term used to describe a group of financial instruments which involves futures, forwards, swaps and options. Derivatives get traded in two types of markets; OTC markets and exchanges. The latter has been conventionally defined by ‘pit’ trading through open outcry but recently they have evolved into electronic trading platforms which have automated the process of matching bids and offers from participants in the market to carry out trades in a multilateral atmosphere (Dodd, 2002). The former are organised along several varying lines. Firstly there is the ‘traditional’ dealer market, followed by the electronically brokered market and finally the proprietary trading platform market (Dodd, 2002). Participants The members of derivative markets are categorised as hedgers or speculators. The hedgers sign a derivative contract designed to mitigate undesirable flux in the asset value or liabilities. This is expressly done by entering into a derivative transaction where a decrease in the asset value is balanced by raising the derivative contract value. Speculators on the other hand, seek to make profit by predicting the market prices flux or rates or credit events, by signing a derivative contract. Taken at face value, these two definitions would indicate that speculators carry out a more risky venture than hedgers which would indicate that they need closer supervision by fiscal supervisory bodies. In practice however, it is more intricate to distinguish them. Jarrow and Turnbull (1999: 20) point out that ‘hedging-risk reduction-speculation- risk augmentations are flip sides of the same coin.’ Trading derivatives is not only confined to hedgers and speculators. There are firms who utilise derivatives in order to get better financing terms. Banks, for example, are prone to offering better funding conditions to corporations that have decreased their market risks by hedging rather than those who have not. Achievement of specific asset allocation is a goal of some fund managers’ use of derivatives for their portfolios. Some passive fund managers of particular index-tracking funds may require utilising derivatives in order to imitate coverage to some fiscal assets that are not so fluid (Chui, 2012). Futures Futures are usually lumped together with forwards because they have a similar feature; both of their contracts are agreements to purchase or sell a particular amount of an asset at a price specified with delivery at a particular future date. However, those that trade in futures are able to realise daily gains and losses as opposed to forwards who transact on a cash on delivery basis. The contracts used in futures are fairly standard in contrast to forwards whose contracts are customised to cater to the needs of the counterparties involved. Futures contracts are settled through the offices of established clearing houses while the forwards must be settled by the counterparties. Due to the fact that they are traded on the exchange, futures are subject to regulation unlike forwards which are usually traded through over the counter contracts (Chui, 2012). Equity futures and options on broad equity indices are regarded as the most frequently alluded to in the area of equity derivative securities. Investors are able to purchase futures which are fashioned on standard stock indices in many international financial centres as shown in figure 1. Figure 1: International Exchanges The NASDAQ Dubai exchange is the only equity derivative exchange in the UAE. The equity derivatives platform was launched in November 2008. In January of 2009 the UAE 20 index dropped by 9.5% to 1,700. This was its third drop in consecutive months. The UAE 20 index is composed of DP World and the DFM has ten stocks, ADX has 9. Stocks are picked for large market capitalisation as well as how investable they are and are subsequently free float weighted. Futures contracts that are listed on the index by NASDAQ Dubai are fashioned as a means to hedge and invest for the GCC as well as international investors. Table 1: Market Share as of January 2010 by Value of Traded Securities. source: NASDAQ Dubai Monthly (2010) Member Market Share % Deutsche Bank 26.19 Citigroup Global Markets 18.86 EFG Hermes 12.77 HSBC 8.87 Credit Suisse Securities (Europe) 8.41 Arqaam Capital 6.25 Shuaa Capital International 3.41 Merrill Lynch International 3.31 Morgan Stanley & Co International  2.29 Mashreq Securities 2.09 Emirates NBD Capital 1.8 Goldman Sachs International 1.43 Emirates International Securities 1.11 DBFS (Mubasher) 1.05 UBS 0.84 Al Ramz 0.61 MAC Capital 0.34 JP Morgan Securities 0.3 SusqueHanna International Securities 0.07 Equities futures trading as of January 2010 in the UAE was as illustrated in the table below: Table 2: Equity Futures Trading (2009) US$ Futures Contracts Value US$ DPW 5,000 245,400 UAE Dirham Futures Contracts Value AED AIRARABIA 690 65,300 DFM 400 63,800 UPP 200 11,700 A look at the daily close of business for the futures exchange on May 1st 2013 shows that trade in futures has not quite picked up momentum on the NASDAQ UAE. Table 3: Close of Business Trading for NASDAQ Dubai on 1st May 2013 Contract Exp. Date Open Price Day's High Day's Low Closing Price Volume Open Interest Currency                 Abu Dhabi Commercial Bank               ADCB Futures - July 2013 Expiry       0     USD ADCB Futures - June 2013 Expiry       0     USD ADCB Futures - May 2013 Expiry       0     USD           0     Air Arabia PJSC                AIRARB Futures - July 2013 Expiry       0     USD AIRARB Futures - June 2013 Expiry       0     USD AIRARB Futures - May 2013 Expiry       0     USD           0     Aldar Properties PJSC               ALDAR Futures - July 2013 Expiry       0     USD ALDAR Futures - June 2013 Expiry       0     USD ALDAR Futures - May 2013 Expiry       0     USD           0     ARAMEX               ARMX Futures - July 2013 Expiry       0     USD ARMX Futures - June 2013 Expiry       0     USD ARMX Futures - May 2013 Expiry       0     USD           0     Arabtec Holding               ARTC Futures - July 2013 Expiry       0     USD ARTC Futures - June 2013 Expiry       0     USD ARTC Futures - May 2013 Expiry       0     USD           0     Dana Gas PJSC               DANA Futures - July 2013 Expiry       0     USD DANA Futures - June 2013 Expiry       0     USD DANA Futures - May 2013 Expiry       0     USD           0     Dubai Financial Market               DFM Futures - July 2013 Expiry       0     USD DFM Futures - June 2013 Expiry       0     USD DFM Futures - May 2013 Expiry       0     USD           0     Dubai Islamic Bank               DIB Futures - July 2013 Expiry       0     USD DIB Futures - June 2013 Expiry       0     USD DIB Futures - May 2013 Expiry       0     USD           0     Dubai Investments               DIC Futures - July 2013 Expiry       0     USD DIC Futures - June 2013 Expiry       0     USD DIC Futures - May 2013 Expiry       0     USD           0     DP World               DPW Futures - July 2013 Expiry       0     USD DPW Futures - June 2013 Expiry       0     USD DPW Futures - May 2013 Expiry       0     USD           0     Drake & Skull International               DSI Futures - July 2013 Expiry       0     USD DSI Futures - June 2013 Expiry       0     USD DSI Futures - May 2013 Expiry       0     USD           0     Emaar Properties PJSC               EMAAR Futures - July 2013 Expiry       0     USD EMAAR Futures - June 2013 Expiry       0     USD EMAAR Futures - May 2013 Expiry       0     USD           0     First Gulf Bank PJSC               FGB Futures - July 2013 Expiry       0     USD FGB Futures - June 2013 Expiry       0     USD FGB Futures - May 2013 Expiry       0     USD           0     Gulf Cement Co               GCEM Futures - July 2013 Expiry       0     USD GCEM Futures - June 2013 Expiry       0     USD GCEM Futures - May 2013 Expiry       0     USD           0     National Bank of Abu Dhabi               NBAD Futures - July 2013 Expiry       0     USD NBAD Futures - June 2013 Expiry       0     USD NBAD Futures - May 2013 Expiry       0     USD           0     RAK Properties               RAKPRO Futures - July 2013 Expiry       0     USD RAKPRO Futures - June 2013 Expiry       0     USD RAKPRO Futures - May 2013 Expiry       0     USD           0     Shuaa Capital               SHUAA Futures - July 2013 Expiry       0     USD SHUAA Futures - June 2013 Expiry       0     USD SHUAA Futures - May 2013 Expiry       0     USD           0     Sorouh Real Estate Co               SOROUH Futures - July 2013 Expiry       0     USD SOROUH Futures - June 2013 Expiry       0     USD SOROUH Futures - May 2013 Expiry       0     USD           0     FTSE NASDAQ Dubai UAE 20 Index               UAE20 Futures - July 2013 Expiry       0     USD UAE20 Futures - June 2013 Expiry       0     USD UAE20 Futures - May 2013 Expiry       0     USD           0     Union Properties               UPP Futures - July 2013 Expiry       0     USD UPP Futures - June 2013 Expiry       0     USD UPP Futures - May 2013 Expiry       0     USD           0     Waha Capital PJSC               WAHA Futures - July 2013 Expiry       0     USD WAHA Futures - June 2013 Expiry       0     USD WAHA Futures - May 2013 Expiry       0     USD           0     Options They operate with contracts that can either be standardised or customised. Options exist in two forms; call options and put options. The former give the buyer access to right to purchase a particular amount of an article of trade or monetary asset at a set price known as the exercise price. This option must be put into effect on or before a specified future date known as the expiration date. The latter contract bestows upon the purchaser the right to sell a particular quantity of an asset at a particular price, on or before a specified future date. These definitions derive meaning from the American style of exercising option which differs from the European style in that the latter only allows the contract to be exercised on the expiration date. During the transaction, the buyer pays the seller who is the writer of the options, a certain amount for the right to buy or sell, known as the option premium. A significant distinction involving options contracts and futures and forwards contracts is the absence of the requirement for buyer to procure or trade the underlying asset whatever the situation. Should the option not be exercised by the time it expires, the buyer makes a loss on the premium paid. Should the options be exercised, the option writer is liable for the costs incurred from any modification in the cost of the underlying that benefit the buyer (Dodd, 2002). Regulation of Derivative Market The NASDAQ UAE exchange has an independent regulator known as the Dubai Financial Services Authority (DFSA) which maintains the official list of securities and also deals with approval of all issuer prospectuses. NASDAQ Dubai also self regulates in a number of ways; It has rules to regulate the process of admission and disclosure for companies wishing to trade their securities on the exchange. They have rules to regulate the companies’ obligations on admittance to trading. Business rules to regulate the process to be followed in order to join NASDAQ Dubai. Regulation of member behaviour on the market and their obligations to their clients. Clearing and settlement procedures. Disciplinary and appeals procedures (NASDAQ Dubai, 2013). Commodities Listed in the Derivative Market of UAE The most commonly traded commodity is crude oil together with its derivatives which include heating oil and gasoline. The other very commonly traded commodity is precious metals such as gold, silver and platinum. Conclusion As can be seen from the above, the derivative markets in the UAE are in their infancy but the potential for growth is enormous. The basic regulatory framework to run the exchange has been put in place along with facilities to run the entity. The uptake of derivatives however, may be a bit slow as can be seen by the close of business trading as depicted in table 3. This would seem to indicate that the public requires further education on trading in these commodities in order to enhance future trade. References Chui, M. (2012). Derivatives markets, products and participants: an overview. Paper presented at the workshop organised by the People's Bank of China and the Irving Fisher Committee, Zhengzhou, 27-29 September 2010 IFC Bulletin No 35. Dodd, R. (2002). The Structure of OTC Derivatives Markets. Derivative Study Centre. The Financier •Vol. 9, Nos. 1-4. Fumham, A. & Arqyle, M. (1998). The Psychology of Money 136-43. Jarrow, R and S Turnbull. (1999). Derivatives securities, South-Western College Publishing. Kom, R. & Kom, E. (2000). Option Pricing And Portfolio Optimization: Modern Methods of Financial Mathematics, ix. NASDAQ Dubai (2013). Overview. Retrieved 8 May 2013 from: http://www.nasdaqdubai.com/exchange/regulatory-framework/overview NASDAQ Dubai Monthly. (2010, February). Retrieved May 8, 13 from: http://feeds.nasdaqdubai.com/newsletter/February2010/English/february2010.html Read More