South Africa's New Rand Futures Market

The South African rand market continues to grow in sophistication and liquidity with every passing year and the structural changes in the South African forex markets in the past five years have been vast. The rand has become the most liquid emerging market currency, and the depth of the market is growing all the time.

When a corporate or an entity such as an asset manager with a rand exposure looked to hedge that risk, they could only approach the over-the-counter market for a solution. The liquidity in the Chicago Mercantile Exchange rand futures and options market was appalling and as a result the regulated exchange traded rand FX futures market never got off the ground. There were a number of reasons for this, most prominent of which were the exchange controls and the parallel London/Johannesburg markets. Exchange controls have helped create what can be termed a parallel market, with one set of rules governing the local participants and another governing the rest of the world. In other words while the monitoring of local participants with reference to rand speculation is strict, the offshore policing of regulations is much more difficult. Thus the pricing and liquidity of rand products can differ. This is more evident in the interest rate markets such as forwards and swaps.

Enter the New Rand Futures Market

South Africa’s JSE Securities Exchange launched a new South African rand futures product on the 18 June 2007. The JSE will use the same Yield X platform used in the trading of interest rate products. Reasons for the move are to create a vehicle through which retail investors can gain access to the FX markets. It could be termed a milestone, as it is the first time that retail investors have been allowed to speculate in the rand FX market in a regulated and controlled manner.

The JSE has been given permission by finance minister Trevor Manuel to begin offering this product and it is hoped that liquidity in the rand will be boosted as a result.

From the outset there are two major South African banks on board acting as market makers, while the stock broking fraternity is expected to carry out much of the marketing for this product.

Trouble in Paradise

From the above and at face value, it would seem that the JSE’s attempt at establishing a rand futures market is a well thought out and organized project. However, the JSE’s limited success with the Yield X might cast some doubt over this. Yield X interest rate products have not been as successful as originally envisaged. Their take up by the asset management and corporate community has been slower than expected. One hopes that the same fate is not destined for the FX product. One could argue that the level of awareness in terms of interest rate derivatives is lower than that of FX derivatives and thus the level of participation in the FX markets would naturally be higher.

However, all the fuss associated with the launch of the rand futures market might be lost on asset managers, corporates and hedge funds. Hedge funds will be barred from participation until they are regulated, corporates will require special permission from the South African Reserve Bank (SARB) to participate and the asset management industry will be limited by their 25% offshore allowance and once these requirements fall away the following questions still need answers:

• Why would an asset manager or hedge fund switch from currently accepted platforms to the Yield X platform? The initial offering will be rand futures only, so how would one do counter hedges on speculative trades? Until they not only have the ability to trade majors but emerging market currencies as well, these questions will remain unanswered
• Furthermore, the traditional contracts for difference markets are already available, and are liquid with every global broker offering a platform from which to trade a myriad of instruments and markets. This gives the institution hedging abilities across markets not to mention adequate liquidity as these platforms are used globally. There are a number of platforms that offer either spot rand trading or futures trading, and seeing as the major use of the rand futures market is going to be speculation, one wonders why anyone would move away from these established products with established liquidity levels?
• Moreover, the regulation and requirements could be seen as onerous, with any extra effort required beyond the products currently available likely to be considered more hassle than it’s worth. Traditionally, speculators provide liquidity, however, a specific requirement of a speculator is the ease of entry and exit into a market. Anything to the contrary will result in speculators staying away.
• Are we not creating a kindergarten rand market of no real consequence? Such a market might not be sustainable over the longer term unless significant funds are committed by some leading asset managers or institutions, which raises another point. Should the policy makers eventually allow real money to participate, will the retail investors not be compromised by virtue of the sophistication and vastly disparate size of transactions? Unless the market is very liquid, retail investors could find themselves on the receiving end of a market moving in the wrong direction for seemingly inexplicable reasons.

So who is the product aimed at? We believe that the retail type clients such as travel agencies and possibly the agricultural community will have the most to gain from the FX futures market, as the contract size is only US$1,000. This is likely to be matched by larger contracts of US$10,000 within six months, should the initial phase be successful. Thoughts surrounding travel agencies centred on the ability of holidaymakers to hedge their holiday funding requirements. Travel agents could market these products on behalf of the market makers, which would be held in the name of the client, not the travel agent concerned.

Rand Future Specifications

• Rand denominated quoted out to 4 decimal places.
• Standardised contracts.
• Fixed expiries in March, June, September and December.
• Cash settled.
• Minimum contract size is $1,000 (foreign underlying currency e.g. US$1,000).

Conclusion

In summary, the average corporate is unlikely to enjoy much benefit from the new futures market, with the requirements from the SARB possibly seen as a barrier and hindrance. Furthermore, most corporates are likely to prefer to deal with the bank’s corporate sales desk for the company’s hedging requirements. If increased liquidity is indeed a primary directive, ease of access for corporates, hedge funds and asset managers should be a priority.