SECURITIES AND EXCHANGE COMMISSION
IN THIS article, we would like to delve into a subject matter that we consider topical, particularly at this point in time – foreign exchange protection or “hedging” as is the financial term.
This article is a follow-up on an earlier article where we introduced the BaDEx. It is absolutely important that both corporates and individuals learn about how the BaDEx can assist hedge against foreign exchange exposures.
The Kwacha has weakened to a record low, extending one of the biggest declines among African currencies this year. The value of the Kwacha has weakened to above the psychological mark of K9 per dollar depreciating in double digits. The trajectory of the local currency is likely to continue on a weak path if the global economic shocks such as a slowdown of China economic fortunes and the anticipated US Federal Reserve interest-rate increase continue to loom large.
Zambia has experienced and continues to experience, volatility and illiquidity in its currency – the Kwacha. This is not unique to Zambia but is common to any asset afflicted by lack of price transparency, lack of liquidity, too few market participants and lack of adequate hedging tools. These shortcomings have the undesired effect of negatively impacting inward investment and sustainable growth in the economy.
Many companies and indeed individuals operating in Zambia are in one form or another exposed to changes in foreign exchange movements.
For these companies and individuals, exposure to foreign exchange transactions introduces foreign exchange risk.
However, these companies and individuals can protect themselves from foreign exchange risk by either obtaining over-the-counter (OTC) solutions from their commercial banks or exchange-traded (ET) foreign exchange solutions from BaDEx.
There are a few differences between the two solutions. The main differences being that OTC solutions from the banks are negotiated between the bank and the customer and, therefore, assume bilateral counterparty risk; usually only large corporate clients with good credit standing can access these products; and customers in these transactions are required to provide cash collateral equal to the amount hedged.
For this reason, OTC solutions may be considered expensive especially for smaller enterprises. The players in this market are the banks. Forward Exchange Contracts are an example of the common OTC transactions (in Zambia) and assume bilateral counterparty risk. As a result, they are only transacted between relatively few counterparts, who view each other’s credit in a favourable light.
The exchange traded hedging contracts offered by BaDEx are available to us many customers as the market can provide. All customers are able to trade in these contracts because the issue of credit risk does not arise because of the presence of a central counterparty (CCP); a market institution whose function is to guarantee trading; and customers are required to pay less than 10 percent of the value of the amount being hedged. Customers enjoy all the benefits of a regulated, transparent futures market.
One of the benefits of an exchange traded market is that it promotes membership. In turn, membership promotes liquidity of the underlying foreign exchange market. For this reason, it is usually cheaper than the OTC solution.
Hedging with BaDEx’s listed contracts is considered less costly due to a reduction of counterparty risk; level playing field among all participants; and less costly plus easy electronic access.
Against this background, it is essential for businesses and individuals to manage the exposure to foreign exchange risk.
The Zambian market desperately needs to begin to use foreign exchange hedging instruments as many firms within Zambia are exposed to foreign exchange risk as they engage in import and export activities.
The business community is desperate for hedging instruments such as exchange traded currency futures contracts. Fortunately, the Zambian market has both OTC and exchange traded derivatives which are best suited to risk management. In summary, the key take-aways are that OTC solutions are provided by commercial banks while exchange traded derivatives are available on the BaDEx. It is important to consider the above discussed points highlighted under OTC solutions and exchange traded derivatives when considering your best option to hedge against foreign currency risk.
BaDEx is a Zambian owned exchange and is regulated by the Securities and Exchange Commission (SEC) which was set up for the purpose of trading financial and commodity instruments on a regulated, electronic trading platform.
All trades clear through a central clearing house, which is the Centralised Depository Systems of Zambia Limited.
In next week’s article, we will further discuss the products (or “instruments”) that currently exist at the BaDEx and illustrate how trading these can allow customers, corporate or individuals, to protect themselves against currency risk.
For more information you can contact BaDEx on peter@badex. co.zm.