Over the last ten years, the capital markets industry in Kenya has experienced rapid changes in the range and sophistication of market products and services as well as in technology.

In response to this, the Capital Markets Authority through industry consultation developed a strategic blueprint in the form of a 10-year Capital Markets Master Plan (Master Plan) to give structured direction to the industry.

As a core objective, the Master Plan is expected to stimulate innovation to broaden product and service offerings, deepen market participation and liquidity, and drive transformative economic development. Under Pillar II, the Master Plan has identified development of the commodities and derivatives markets as a key milestone.

As we facilitate achievement of this aspiration, it’s imperative to deepen our markets through new sophisticated products to complement the traditional fixed income and equity securities.

The authority approved the Nairobi Securities Exchange (NSE) to operate a derivatives exchange market that is compliant with the Capital Markets (Derivatives Market) Regulations, 2015.

The Regulations impose certain responsibilities on the NSE which include establishment of Rules governing the conduct of NSE Derivatives members and their clients, supervision of Derivatives Market and its members, regulation of NSE clearing and settlement systems and enforcing compliance with the NSE Derivatives Market Rules.

Derivatives markets can be broadly classified into two categories namely; over-the-counter (OTC) traded instruments and Exchange-traded instruments. OTC traded instruments are contracts that are privately negotiated and traded directly between two parties, without going through a securities exchange.

They constitute mainly forwards and swaps and are regulated through agreed contracts drawn out of International Swaps and Derivatives Association (ISDA) agreements. OTC traded instruments are already traded in Kenya by banks and large corporations. Exchange-traded instruments differ from OTC instruments in structure.

They are standardised in nature and are transparently traded on a securities exchange. The unique aspect of a derivatives exchange is the reduction of settlement risk through collection of margin deposits from buyers and sellers; and existence of a default process which guarantees settlement for investors.

The derivatives market structure in Kenya includes a clearing house known as NSE Clear, a wholly owned subsidiary of NSE PLC. The clearing house will be responsible for ensuring settlement finality and centralised clearing of all contracts through a process known as novation. Novation allows one party to assign its obligations to another party, which is essentially the same as selling a futures contract.

This means that the NSE Clear will be a buyer to every seller and seller to every buyer. To assist in the settlement process, the NSE has appointed two commercial banks - Co-operative Bank of Kenya and Stanbic Bank to serve as clearing members.