COMSATS INSTITUTE OF

INFORMATION TECHNOLOGY, ISLAMABAD

DERIVATIVES AND FINANCIAL RISK

MANAGEMENT

SUBMITTED BY
FARAZ AHMAD KHAN
CIIT/SP14-BAF-028/ISB

SUBMITTED TO
SIR DR MUHAMMAD KHALID SOHAIL

DATE OF SUBMISSION
OCT 13, 2017
DERIVATIVES MARKET IN PAKISTAN

Certain factors such as Pakistan’s recent MSCI reclassification to emerging market status and
inclusion in the ‘Next-11’ group, an improvement in macro-economic indicators, a decline in
discount and deposit rates, and the need for leverage-based products may positively impact the
derivatives markets in the country. A few recommendations may help in promoting and
developing the nascent Pakistani derivatives markets.

Reasons

First, it is appropriate to understand and address the concerns of the supply-side market
participants.

Second, a comparative analysis of regulatory frameworks in neighboring countries, other

emerging markets, and developed markets would help in formulating the regulatory levels that
not only safeguard investors’ interest but also promote the derivatives markets.

Third, the innovation of Shariah-compliant derivatives contracts may attract investors who view
derivatives as purely speculative instruments.

Fourth, appropriate measures to promote the marketability of derivatives, as well as cash

liquidity of the supply-side market participants, should be considered. While the former can be
achieved by low transaction costs, price discovery, high volumes, and enhancement of the
market’s resilience to negative shocks, the latter can be achieved by keeping the margin
requirements at a level that do not increase the opportunity cost for retail and institutional
investors.

Fifth, financial literacy and confidence building among investors, regulated marketing campaigns
in simple language, and increasing the reach of investment companies through online platforms,
satellite offices, and already established banking networks may motivate retails investors to opt
for investments in derivatives.
Lastly, encouraging investors’ participation in derivatives markets through mutual funds and
voluntary pension schemes within the realm of respective investment policies would also deepen
the derivatives markets.

In Pakistan, the derivatives market is in the nascent stage. It has just started to emerge with few
contracts of forward trade agreements, plain vanilla swaps and currency options. The total
volume of transactions is around Rs5 billion. As the market is not fully developed to take large
exposures, the State Bank says it "has been actively intervening in these riskier initiatives of the
banks". All derivative agreements require formal approval of the central bank, given on a case-
to-case basis, considering the concerned bank's potential of risk management.

Further efforts

Karachi Stock Exchange (KSE) shows a better growth rate in perspective of financial derivatives
but KSE also faces high degree of volatility. Now days, KSE is considered highest volatile
market in derivative all over the world. Main user of derivatives is Telecom Sector,
transportation Sector, Banking Sector, financial institution and power sector in Pakistan during
2007-2012. If we use such derivative for purely hedging purpose such instrument are very
helpful but excessive speculation on such instrument lead the market toward volatility which
hampers not only the market but also the derivative prospective. Better policy in this concern not
only will increase the size of stock market but also will provide the depth of market, tax
advantage, investor confidence and business growth Statutory restriction on different institution
also hinder the pace of derivative progress in Pakistan like mutual fund only may use only 10%
of assets in derivatives. Fragile economy is also major problem which hinder the true spirit of
derivatives in recent era. There are many factors which increase need of derivative day by day
i.e. financial ease, limited access to sources of funds and multi-national business emergence. It
should also be noted that many crises are owing to high investment in derivative like East Asia
crises 1990 and 2005 in Pakistan.