The basic assumption is that having a well functioning derivatives market is in

The basic assumption is that having a well

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regulations. The basic assumption is that having a well-functioning derivatives market is in the interest of all concerned. IMF (2002) found out that the most common problems that constrain the development of local derivatives markets are relatively underdeveloped markets for underlying instruments, weak or inadequate legal and market infrastructure and restrictions on the use of derivatives by local and foreign entities. MFA (2008) identified several trends which have characterized the development of derivatives exchanges in emerging markets. First, the consolidation of exchanges within or between countries aimed to achieve higher efficiency and market. Olatundun (2009) pointed that South Africa success was as a result of their gradually relaxing exchange controls and further developing its financial market with the introduction of the currency futures market. According to Mugo (2009) introducing derivatives exchange based on Asia’s emerging markets, the study concluded that derivatives’ trading has immense benefits and stressed that emerging markets should strive to establish derivatives markets to enjoy the benefits of derivative trading as enjoyed by most developed markets. 2.4.2 Legal/Regulatory framework and development of derivatives market Legal, regulatory, and prudential frameworks should be developed for purposes of governance and supervision of the markets. The three basic objectives of regulation are to protect market integrity, to ensure fierce levels of competition, and to prevent fraud (Sewel, 2007). a) Clearinghouse privileges and taxes Clearinghouse privileges and taxation are the main legal issues that need to be addressed in the development of derivatives markets. Creating the desired contract structure for trading in the exchanges can be complicated and thus the clearinghouses needs protection of the law and also make necessary efforts to avoid ranking as regular creditor in margin funds in events of bankruptcies for it to operate effectively. This may require capital markets laws to be changed to accommodate derivatives trading needs (Alberta Market Solutions Ltd., 2003). Taxes tend to constitute an increase in explicit transaction costs, which could affect market 20
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liquidity. Such taxes can become impediments to the creation of deep and liquid markets in the sense that raising trading costs can constitute an entry barrier, attracting fewer dealers and investors (Ahuja, 2006). Government should weight the potential increase in tax revenues against the potential decline in market liquidity. If imposed, should be levied so as to minimize their impact on market liquidity. Furthermore, certain tax exemptions can create further incentives to the entrance of new investors in the market. For instance, reducing taxation for foreign investors can sometimes contribute to increase investors shape in number and investment horizons (Le-Grazie and Fernandez, 2007).
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