ISMAIL MUSA and PETER AMODU
The Central Bank of Nigeria (CBN) in collaboration with FMDQ Holdings PLC ( “FMDQ Group”), have introduced the much awaited long-dated FX Futures, extending the maximum contract tenor to up to five (5) years.
The new introduction yet again shows CBN’s commitment towards the development of the foreign exchange (FX) market and indeed, the Nigerian financial markets, as the apex bank. The foreign exchange hedging elongated tenure, implies that 47 new monthly OTC FX Futures contracts, in addition to the existing 13 contracts have been introduced from February 13, 2020, bringing the total number of open OTC FX Futures contracts at any point to 60.
As the pioneer and sole seller of the Naira-settled OTC FX Futures contracts, the CBN, having successfully sold a total value of circa $34.83 billion so far on FMDQ Securities Exchange Limited (“FMDQ Exchange”), made history with the landmark achievement following the launch of the product in June 27, 2016, , to the relief of Nigerian corporates, foreign portfolio investors (FPIs), foreign direct investors (FDIs) and other investors, as the product served to minimise the disequilibrium in the Spot FX market and caused the exchange rate to moderate; attracting significant capital flows to the Nigerian fixed income and equity markets; and achieving exchange rate stability.
With this product administered via the bespoke FMDQ FX Futures Trading & Reporting System, it is noteworthy that since the introduction of the product almost four (4) years ago, there has been no settlement default, with FX Futures contracts over the last 43 maturities, totalling circa $25.53 billion, successfully cleared and settled by FMDQ’s wholly owned clearing house, FMDQ Clear Limited (“FMDQ Clear”).
In the global financial system, hedging products are market enablers, allowing businesses and investors around the world to invest freely across borders, effectively hedge their risks and invariably contributing to economic growth.
With the FX Futures contracts, the effective rate at which a counterparty will purchase (or sell) FX at any given time in the future is predetermined and fixed; essentially obligating the parties to the transaction which is consummated on FMDQ Exchange, to purchase or sell a currency (in this case, US Dollar) on a predetermined future date (the settlement date) for a fixed rate agreed on the date a contract is entered (trade date).
No obligation exists for the physical delivery of the currency and at maturity, clearing and net settlement which is effected by FMDQ Clear, is made in Naira based on the US Dollar notional amount, and determined by the difference between the agreed rate (on trade date) and the rate on maturity (on settlement date) as determined by FMDQ’s FX reference rate – the Nigerian Autonomous Foreign Exchange Fixing –NAFEX.
Under the erstwhile OTC FX Futures market structure, the CBN offered 13 monthly contracts allowing market participants hedge FX exposures for up to a 1-year period. Whilst this was a welcome development, a gap was identified where investors seeking to hedge FX risk longer than one (1) year were unable to achieve a perfect hedge using the FX Futures product due to the maturity mismatch.
The resultant risk of unwanted variability in the product deterred investors from using OTC FX Futures market for long-term capital hedging as this was considered unsuitable for long-term investment and capital budgeting purposes, leaving the Nigerian financial markets struggling to attract much-needed FPIs/FDIs and long-term foreign currency (FCY) denominated borrowings for sustainable development and economic growth.
The impact of the extension of the hedge curve by the CBN to up to 60 months can therefore not be overemphasised as this will greatly reduce potential FX exposures, encourage long-term planning and increase investments in the Nigerian financial markets.
Bola Onadele. Koko, Chief Executive Officer of FMDQ Group, in a statement said, “We are excited that the CBN has yet again introduced this revolutionary initiative which will minimise the funding liquidity risk of CBN’s FX Management Blotter and significantly attract capital, incentivise domestic corporates to avail on low-interest rate FCY loans, as well as encourage FPIs/FDIs seeking to make medium-to-long-term investments in our economy.
This product innovation, which will continue to provide opportunities for the government, businesses, fund managers investors, individuals etc. to hedge to manage exchange rate risk, thus achieving greater market confidence, liquidity, improvement in business planning, better allocation of resources, global competitiveness of the Nigerian financial markets, and in all, a thriving economy.”
With derivative products continuing to prove to be very useful tools for investors and the financial market in general, FMDQ Group, through its Exchange subsidiary, following the activation of its Derivatives Market Development Project and subsequent stakeholder engagements cutting across various market participants including banks, fund managers, regulators, media etc., is set to introduce
new derivatives products into the Nigerian financial markets; and FMDQ Clear, positioning as a central counterparty (CCP) in the near-term, shall continue to provide effective risk management services for derivatives products, ensuring trades are cleared and settled in a timely, secure and efficient manner.
With its renewed aspiration as encapsulated in its mission to collaborate with the markets for economic progress towards delivering prosperity, FMDQ Group, comprising FMDQ Exchange, FMDQ Clear and FMDQ Depository, having consolidated its activities into a fully diversified platform (fixed income, currencies and derivatives markets) and vertically integrated financial market infrastructure group (providing a one-stop platform for execution, clearing and settlement of trades), is strategically positioned to support the upgrade of the Nigerian financial markets and indeed, the economy to become globally competitive, operationally excellent, liquid, and diverse, in line with the Group’s GOLD Agenda.
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