Nigeria’s OTC FX Futures Market to address FX needs of Corporates

There is light at the end of the tunnel for Corporates operating in Nigeria as they can now breathe a sigh of relief with the introduction of the Naira-settled OTC FX Futures market.

The Naira-settled OTC FX Futures market will be kicked off by the Central Bank of Nigeria (CBN) on June 27, 2016, who will be the seller of the OTC FX Futures contracts of non-standardised amounts for different tenors.

The tenors will be between one (1) month and up to two (2) years, settling on bespoke maturity dates, providing liquidity in the product that will enable corporate treasurers effectively and efficiently manage their FX risk.

FMDQ OTC Securities Exchange (FMDQ) will be the OTC FX Futures Exchange, organising the smooth running of this market through its System, the FMDQ OTC FX Futures Trading & Reporting System.

FMDQ OTC Securities Exchange market trading standards and rules will be providing the requisite transparency and governance for the success of the market.

Ahead of the establishment of a Central Counter party (CCP), the Nigeria Inter-Bank Settlement System Plc (NIBSS) will act as the clearing and settlement infrastructure for the margining and settlement of the OTC FX Futures contracts.

On June 15, 2016, the CBN in what the local and international markets alike have said to be a bold unexpected but very welcome move released the “Revised Guidelines for the Operation of the Nigerian Inter-Bank Foreign Exchange
Market”.

The Guidelines set out the structure of the Nigerian FX market towards building an efficient, liquid, transparent and globally competitive FX market – a single market (the autonomous/inter-bank FX market), with the CBN performing strictly an interventionist role through its FX Primary Dealers (FXPDs), supported by the introduction of risk management products (newest of which is the Naira-settled OTC FX Futures product).

The introduction of the Naira-settled OTC FX Futures market is long-awaited respite for corporates that have been operating in the nation over the last fifteen (15) months and had been faced with major
challenges in the FX market, as this may just be the elixir they have been waiting for to give them the much needed
certainty to ensure effective and efficient business planning, and indeed to keep operations going.

The Naira-settled OTC FX Futures can be defined as non-deliverable forwards i.e. contracts that obligate the counterparties to purchase or sell a specific currency (the US Dollar, which is a notional amount) on a predetermined future date (the settlement date) for a fixed rate agreed on the date the contracts were entered into (trade date).

Simply put, the Naira-settled OTC FX Futures contracts can be used to hedge a corporate’s exposure to FX (in this situation, the US Dollar) whereby the rate at which the corporate will purchase (or sell) FX at a period of time in the future is predetermined and fixed.

There is no obligation for the physical delivery of the currencies (Naira or US Dollar)
and at maturity, net-settlement will be made in Naira based on the US Dollar notional amount, and determined by the difference between the agreed rate (on trade date) and spot FX rate (on settlement date).

CBN, through the FMDQ OTC FX Futures Trading and Reporting System will offer the Naira-settled OTC FX Futures contracts to all Authorised Dealers (and may in addition deal directly with its FXPDs on a two-way quote basis) who will in turn offer same to customers with trade-backed transactions.

The OTC FX Futures quotes will also be made available on the FMDQ website.

Authorised Dealers as well as corporate treasurers may also be sellers of OTC FX Futures in the market, thereby improving liquidity in the market. For credibility of the contracts, especially at maturity, the Spot FX rate will be the FMDQ Spot FX Rate Benchmark – the Nigerian Inter-Bank Foreign Exchange Fixing (NIFEX) an independent fixing of the inter-bank FX market.

What will this mean for corporate treasurers operating in the Nigerian FX market? There is no longer the need to front-load FX requirements, which puts immense pressure on and distorts the Spot FX rate. Corporate treasurers are better able to make judgments on when to access the Spot FX market, managing more effectively, their liquidity positions.

The demand for the US Dollar by end-users can be staggered appropriately as there will be no requirement for “panic-buying” as end-users are guaranteed a fixed rate for their FX needs when required.

Indeed, corporate treasurers may consider it prudent to even delay the purchase of their US Dollars in the Spot FX market for a week to observe the OTC FX Futures rates before buying Spot FX.

If the rate in the Spot FX market is higher than the OTC FX Futures rate of a particular tenor, US Dollars will be borrowed (or trade finance obtained) and a simultaneous hedge of the exchange rate exposure will be entered into via the attractive OTC FX Futures contract, and at maturity, US Dollars will be accessed from the Spot FX market at the applicable Spot FX rate and the differential paid to achieve the initially agreed rate on the OTC FX Futures trade date.

The Naira-settled OTC FX Futures product, whilst of tremendous benefit to Nigerian corporates, is equally of immense importance and advantage to, among others, the CBN, the Nigerian FX market, and the nation’s economy as a whole.

The Naira-settled OTC FX Futures market will serve to, inter alia, minimise the disequilibrium in the Spot FX market and cause the rate to moderate; attract significant capital flows to the Nigerian fixed income and equity markets; and achieve exchange rate stability.

As the nation waits in positive anticipation for the kick-off of the Nigerian FX market this week, corporate treasurers especially, can, without any fear, pause, take a breath, and wait eagerly for the commencement of the Market watchers say Naira-settled OTC FX Futures market which will present a whole host of opportunities for corporate treasurers as they plan their business requirements and manage as efficiently and as effectively, as ever before, their FX exposures.