Abstract
This chapter discusses some of the key obstacles for the launching of successful derivative products in emerging economies and proposes some policy measures, governance practices and regulations with the objective of setting unambiguous operational platforms, sound regulations and effective oversights within financial markets and institutions. In this regard, key regulatory and operative processes and guidelines, which should be carefully evaluated prior to starting the operational aspects of formal derivatives securities markets, are reviewed and tailored to the particular requirements of emerging markets ecosystem. This chapter will appeal to those concerned in launching of coherent and reliable operational platforms for the trading of derivatives products in emerging markets, primarily in the wake of the outcomes of the 2007–2009 global financial meltdown and the COVID-19 health crisis.
This chapter is a collated, but largely extended version, of the author previous research works published by Emerald, and Palgrave Macmillan (Springer Nature), under the following titles: Al Janabi 2006, 2008a, 2008b, 2012a).
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
Derivative securities derive their value from their connected underlying assets; and are traded on organized exchanges and over-the-counter (OTC) markets. Nevertheless, organized exchanges have significantly grown; however, OTC derivatives still account for a large portion of the total market value of derivative products. In essence, there are two major classifications of derivative products, depending on whether the client has the right (options contracts) or the obligation (forwards, futures, and swap contracts).
In line with Das (2010): ‘Derivatives are used to speculate, manufacture exotic risk cocktails, keep dealings off-balance sheet and out-of-sight, increase leverage and arbitrage regulatory or tax rules. The reality that industry participants will not acknowledge is that hedging and risk management is secondary to the other uses’ (Das 2010). ‘For companies, the ability to use derivatives trading to supplement traditional earnings, which are under increased pressure, is irresistible. For institutional and retail investors, the use of derivatives to improve returns through leverage and access to different risks is now a vital part of the investment process’ (Das 2010).
- 2.
For further discussion on liquidity risk and Liquidity-Adjusted Value-at-Risk (LVaR) literature using Al Janabi model, we can refer the readers to Madoroba and Kruger (2014) and Al Janabi (2011, 2012b, 2013, 2014) research papers. In their paper, Madoroba and Kruger (2014) review and compare ten liquidity risk VaR models, including Al Janabi model. In his research papers Al Janabi (2011, 2012b, 2013, 2014) present a robust and novel machine learning technique and optimization algorithms, which is based on Al Janabi model (Madoroba & Kruger 2014; Al Janabi 2008c), for the computational process of a closed-form parametric LVaR. Indeed, Al Janabi model and its related optimization algorithms can be used in machine learning processes for a direct computational process of market and asset liquidity trading risks, and within a multivariate context for multiple-assets portfolios. In addition, the robust Al Janabi model (Madoroba and Kruger 2014; Al Janabi 2008c) is quite simple to implement even by very large financial institutions with multiple assets and risk factors. For other relevant literature on liquidity risk, internal risk models, and portfolio selection one can refer as well to Asadi and Al Janabi (2020), Al Janabi (2020), Arreola-Hernandez and Al Janabi (2020), Grillini et al. (2019), Al Janabi et al. (2017), Al Janabi et al. (2019), Madoroba and Kruger (2014), Arreola-Hernandez et al. (2017), Arreola-Hernandez et al. (2015), among others.
- 3.
Because of the “first-mover-effect”, derivative exchanges in emerging markets need to design innovative and competitive products combined with long-term-planning.
- 4.
In the media of certain emerging markets, which are infamously recognized as illiquid standardized derivatives exchanges, there were some bragging press interviews with senior management regarding the development of new contracts on electricity, inflation and gasoline, etc. with the objective of competing with other very well recognized derivatives houses, such as, the Chicago Mercantile Exchange (CME). These self-delusion attempts must be examined carefully and compared with the experiences of other regional derivatives markets because of the “first-mover-effect”. In addition, it is important to emphasis that the trading of derivatives contracts on electricity is not an easy ride, as it requires considerable infrastructure to deal with this kind of contracts, such as pricing and valuation and regulations, etc. These contracts are notoriously known to have huge volatility (due to the different peak hours for electricity consumption during the day), let alone the peculiarity of electricity as an asset since it is generated instantaneously and cannot be stored like many commodities.
- 5.
For further discussion on the development and implementation of derivatives securities in other emerging markets such as Chile, one can refer to Fernandez (2006).
References
Acharya VV, Brenner M, Engle RF, Lynch AW, Richardson M (2009) Derivatives: The ultimate financial innovation. In: Acharya VV, Richardson M (eds) Restoring financial stability: how to repair a failed system. John Wiley, New Jersey
Al Janabi MAM (2006) On the inception of sound derivative products in emerging markets: real-world observations and viable solutions. J Financ Regul Compliance 14(2):151–164
Al Janabi MAM (2008a) Internal regulations and procedures for financial trading units. J Bank Regul 9(2):116–130
Al Janabi MAM (2008b) On the appropriate function of trading risk management units: principal objectives and adequate use of internal models. J Bank Regul 10(1):68–87
Al Janabi MAM (2008c) Integrating liquidity risk factor into a parametric value at risk method. J Trading, summer issue, 76–87
Al Janabi MAM (2011) A generalized theoretical modeling approach for the assessment of economic capital under asset market liquidity risk constraints. Serv Ind J 31(13 & 14):2193–2221
Al Janabi MAM (2012a) Derivatives securities in emerging MENA markets: structuring lessons from other financial markets. J Bank Regul 13(1):73–85
Al Janabi MAM (2012b) Optimal commodity asset allocation with a coherent market risk modeling. Rev Financ Econ 21(3):131–140
Al Janabi MAM (2013) Optimal and coherent economic-capital structures: evidence from long and short-sales trading positions under illiquid market perspectives. Ann Oper Res 205(1):109–139
Al Janabi MAM (2014) Optimal and investable portfolios: an empirical analysis with scenario optimization algorithms under crisis market prospects. Econ Model 40:369–381
Al Janabi MAM (2020) Multivariate portfolio optimization under illiquid market prospects: a review of theoretical algorithms and practical techniques for liquidity risk management. J Modell Manage (in press)
Al Janabi MAM, Arreola-Hernandez JA, Berger T, Nguyen DK (2017) Multivariate dependence and portfolio optimization algorithms under illiquid market scenarios. Eur J Oper Res 259(3):1121–1131
Al Janabi MAM, Ferrer R, Shahzad SJH (2019) Liquidity-adjusted value-at-risk optimization of a multi-asset portfolio using a vine copula approach. Phys A 536:122579
Arreola-Hernandez J, Al Janabi MAM (2020) Forecasting of dependence, market and investment risks of a global index portfolio. J Forecast 39(3):512–532
Arreola-Hernandez J, Hammoudeh S, Khuong ND, Al Janabi MAM, Reboredo JC (2017) Global financial crisis and dependence risk analysis of sector portfolios: a vine copula approach. Appl Econ 49(25):2409–2427
Arreola-Hernandez J, Al Janabi MAM, Hammoudeh S, Nguyen DK (2015) Time lag dependence, cross-correlation and risk analysis of U.S. energy and non-energy stock portfolios. J Asset Manage 16(7):467–483
Asadi S, Al Janabi MAM (2020) Measuring market and credit risk under Solvency II: evaluation of the standard technique versus internal models for stock and bond markets. Eur Actuar J. https://doi.org/10.1007/s13385-020-00235-0
Boyle P, Boyle F (2001) Derivatives: the tools that changed finance. Risk Books
Das S (2006) Trader, guns and money: knowns and unknowns in the dazzling world of derivatives. FT Prentice Hall, Pearson Education, Harlow
Das S (2010) Regulation and the derivatives markets, Financial Times. https://www.ft.com/markets, Published on June 7, 2010.
Das S (2011) Extreme money: masters of the universe and the cult of risk. FT-Pearson Education, UK
Fernandez V (2006) Emerging derivatives markets: the case of Chile. Emerg Mark Financ Trade 42(2):63–92
Financial Stability Board (2020a) COVID-19 pandemic: Financial stability implications and policy measures taken—Report to the G20. Basel. https://www.fsb.org/wp-content/uploads/P150720-2.pdf. Published on July 15, 2020a
Financial Stability Board (2020b) Guidance on financial resources to support CCP resolution and on the treatment of CCP equity in resolution: consultative document. Basel. https://www.fsb.org/wp-content/uploads/P020520.pdf. Published on May 4, 2020b
Financial Stability Board (2020c) COVID-19 pandemic: financial stability implications and policy measures taken. Basel. https://www.fsb.org/wp-content/uploads/P150420.pdf. Published on April 15, 2020c
Glasser TD (2013) Leveraging data for financial stability monitoring. J Bank Regul 14(3 and 4):195–208
Grillini S, Sharma A, Ozkan A, Al Janabi MAM (2019) Pricing of time-varying illiquidity within the Eurozone: evidence using a Markov switching liquidity-adjusted capital asset pricing model. Int Rev Financ Anal 64:145–158
Holder ME, Thomas III MJ, Webb RI (1999) Winners and losers: recent competition among futures exchanges for equivalent financial contract markets. Deriv Quarter, Winter Issue
Madoroba SBW, Kruger JW (2014) Liquidity effects on value-at-risk limits: construction of a new VaR model. J Risk Model Valid 8:19–46
Steinherr A (2000) Derivatives the wild beast of finance: a path to effective globalisation? John Wiley, New York
Tsetsekos G, Varangis P (2000) Lessons in structuring derivatives exchanges. World Bank Res Obs 15(1):85–98
Author information
Authors and Affiliations
Corresponding author
Editor information
Editors and Affiliations
Ethics declarations
Conflict of Interest
The author declares no conflict of interest in this chapter.
Funding
This research study did not receive any funding from any entity or organization.
Rights and permissions
Copyright information
© 2023 The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd.
About this chapter
Cite this chapter
Al Janabi, M.A.M. (2023). Governance Practices and Regulations for Derivative Products in Emerging Markets in the Wake of the COVID-19 Pandemic and the Subprime Global Financial Meltdown. In: Çalıyurt, K.T. (eds) Corporate Sustainability in Times of Virus Crises. Accounting, Finance, Sustainability, Governance & Fraud: Theory and Application. Springer, Singapore. https://doi.org/10.1007/978-981-19-9079-3_5
Download citation
DOI: https://doi.org/10.1007/978-981-19-9079-3_5
Published:
Publisher Name: Springer, Singapore
Print ISBN: 978-981-19-9078-6
Online ISBN: 978-981-19-9079-3
eBook Packages: Business and ManagementBusiness and Management (R0)