NIGERIAN SHAREHOLDERS AND DERIVATIVES TRADING

           Nigerian investors are in dire need of managing volatility by hedging their risks, writes Sola Oni

Investors globally are under pressure. Uncertainty of fiscal and monetary policies have become monsters that threaten investment decisions. Investors are searching through the rabbit hole for where they can realize alpha returns at lowest risk. Investment in bonds which hitherto serves as a safe haven for risk averse investors is fast losing steam in the international bond market.

As at Monday, this week, Nigeria’s 10-year Eurobond recorded one of the worst yields in the year. It closed the first half of the year at a yield of 13.45 percent or $69.8 in unit price. Bloomberg’s recent data indicates that Investors are dumping Nigerian Eurobonds and the bond prices are plummeting. This is the trend in emerging markets following rise in interest rates globally.

Share prices of blue chip companies in the Nigerian financial market like many other markets daily contend with diminution. The increase in the Monetary Policy Rate (MPR) from 11.5 % to 13.5 % by Central Bank of Nigeria (CBN) has provided an ample opportunity for speculators to press panic button and move their funds from the capital market to money market. However, stock market has self- correcting mechanism and the market shall ultimately find its equilibrium prices.  More than ever, Nigerian investors are in dire need of managing volatility by hedging their risks.

In my article, entitled: “ Time for Derivative Trading in Nigeria “, published by many national dailies and prominent Online Platforms in early March, 2021, I stated that  trading in derivatives thrives in an atmosphere of functioning spot market for the underlying assets, assured liquidity, defined market structure, legal compliance, and investor acceptance. The Nigerian Exchange Limited (NGX), has been long positioned for derivative trading. Apart from having the basic infrastructure, spot market for underlying assets is as old as the history of Nigerian economy.

At the basic level, Derivatives are financial instruments or contracts whose value are derived from that of underlying assets. They are complex financial contracts between two or more parties and their prices are derived from fluctuations in the prices of underlying assets. The underlying assets are equity, fixed income securities, commodities, currencies, interest rates and market indices, among others. 

As an asset class, derivative instruments are risk management tools. The four basic types of derivatives are forward, future, options, and swaps. But the most complex among them is option. The major players in the derivative market are the hedgers who use derivatives to reduce risk, the speculators or traders who are risk takers and arbitrageurs who take advantage of price discrepancies in different markets to make riskless profit.

NGX as a normal market cannot be insulated from volatility due to many factors, especially exogenous ones. A major risk that global investors face at the moment is rising inflation. It is no longer the headache of investors in emerging economies alone as inflation has put some developed economies in a quandary. Recently, news broke that the United Kingdom’s inflation has skyrocketed to a new 30-year at 6.2 percent. Although it is far below that of Nigeria’s current 15. 9 percent, the Bank of England is not comfortable with its country’s figure. In order to curtail rising prices across the board, the Bank has raised interest rate thrice since mid -December last year from 0.5 percent to 0.75 percent as it fears that the scourge may peak at 8 percent.

On Thursday, April 14, 2022, Nigerian Exchange Limited (NGX),  made history and hit the headlines for its launch of West Africa’s first Exchange Traded Derivatives (ETDs) Market with Equity Index Futures Contracts. Successive administrations of NGX had initiated the need for its trading over the years.  By its announcement, NGX is flagging off with innovative two Equity Index Futures Contracts; NGX 30 Index Futures and NGX Pension Index Futures, were listed on the market with strong prospects of more securities to be traded in the derivatives space.

The take-off of NGX ETD has been reinforced with the Exchange’s collaboration with NG Clearing Limited, a Premier Central Counter-party(CPP) in Nigeria. Access Bank and Zenith Bank emerged the pioneer clearing members while Cardinal Stones Securities Limited, Meristem Securities Limited and APT and Funds Limited have made history as the first Trading License Holders.

Commenting on the launch of ETD, the Chief Executive Officer of NGX, Temi Popoola said: “NGX remains committed to building an exchange that can cater to the increasingly sophisticated needs of domestic and foreign investors. A strong pillar in our strategy is to enhance liquidity and expand market capitalisation to the end that we create value for stakeholders, and the introduction of ETDs is a critical step in the right direction. The platform will play an essential role in broadening and deepening the market, adding new impetus to NGX’s leading position as Africa’s preferred exchange hub.”

Moves towards Derivative trading on The Exchange had commenced during the administration of Professor Ndi Okereke-Onyuike, just like the demutualisation of the market. The good thing is that successive administrations did not jettison the laudable projects like the usual practice in the public sector in Nigeria.

As hedging instruments, ETDs are standardised, highly regulated, and transparent financial contracts listed and traded on a securities exchange, and guaranteed against default through the clearing house. The initiative is to further enhance the participation of domestic and international investors in Nigeria’s financial markets with multiplier effects on the performance of the economy.

A major risk that global investors face at the moment is rising inflation. It is no longer the headache of investors in emerging economies alone as inflation has put some developed economies in quandary. Recently, news broke that the United Kingdom’s inflation has skyrocketed to a new 30-year at 6.2 percent. Although it is far below that of Nigeria’s current 15. 9 percent, the Bank of England is not comfortable with its country’s figure. In order to curtail rising prices across the board, the Bank has raised interest rate thrice since mid -December last year from 0.5 percent to 0.75 percent as it fears that the scourge may peak at 8 percent.

In the United States, inflation rate has hit 7.9 percent, the highest in 40 years. Consequently, America’s Federal Reserve is contending with options to tame the rising inflation. The Bank knows that it is obligatory for every central bank to inspire confidence in the economy by keeping inflation low. Godwin Emefiele is sweating under his sparkling suit as Nigeria’s Central Bank struggles to fight inflation among other macroeconomic vagaries that torment the economy.

 Rising energy prices following the ongoing war in Ukraine is a signal to the global community that imported inflation is waxing stronger. Shareholders are vulnerable to making  flawed  assumption of inflation and monetary and fiscal policy. This may jeopardize their investment decision. At this juncture, commencement of NGX ETD could not have come at a better time.  Shareholders need comprehensive and sustained enlightenment on how derivatives work.

They should be exposed to the risks and reward trade off of this hedging instruments. At this point in time investors also require a knowledge of Inflation derivatives.  Equity derivatives are financial products or instruments whose value is partly derived from an increase or decrease of one or more underlying equity securities or assets. These class of derivatives are usually used for hedging or speculation purposes. The most common equity derivatives are options and futures. They serve as agreements between a buyer and a seller to either buy or sell at a predetermined price; the parties can either hold the right or the obligation to trade the asset at the expiry of the contract.

This type of derivatives provides opportunities for investors to minimize potential risks of rising inflation. By investing in inflation derivatives, an investor can speculate future trends of inflation as a risk aversion measure. Investors need to deep knowledge about the products and the industry to trade in derivatives. However, investing in equity derivatives comes with a few risks such as interest rate risk, currency risk, and commodity price risk

Oni, an integrated Communications Strategist, Chartered Stockbroker and Commodities Trader,  is the Chief Executive Officer, Sofunix Investment and Communications.