Commercial banks taking dollar-denominated loans should hedge the facility against risk of currency fluctuations, FMDQ OTC Securities Exchange Managing Director/CEO Bola Onadele has said.
Speaking during the financial markets workshop in Lagos, he said banks borrowing dollars needed to protect themselves through hedging. “Anyone that takes foreign currency loan should hedge, that is the opportunity the Central Bank of Nigeria (CBN) has provided,” he said.
He explained that hedging/derivatives were primarily risk management instruments that enable participants to price and transfer (hedge) financial risks such as market/price risk, foreign exchange risk, and interest rate risk.
According to him, hedging reduces the risk of exposures to unforeseen circumstances. Hedging is a risk management strategy used in limiting or offsetting probability of loss from fluctuations in the prices of commodities, currencies, or securities.
Speaking further, Onadele said: “The banks that are borrowing dollars when they have to pay back, they have to pay back in dollars. They have to protect themselves, through hedging. Anyone that takes foreign currency loan should hedge, that is the opportunity the Central Bank of Nigeria (CBN) has provided. The rates are low in dollars, so you are tempted to borrow in dollars at four per cent instead of borrowing in naira at 20%”.
He said that derivatives improve risk management and business planning, increases credit to critical sectors of the economy to drive growth, increase capital flow from Foreign Portfolio Investors, increase liquidity in the system and promote Market Efficiency and Sophistication as well as financial system stability.
He said that 92% of the world’s 500 largest companies manage their price risks using derivatives, adding that notional principal of derivatives increased by 642.17% from $93.02 trillion in 1998 to $690.37 trillion in 2018, which is over eight times the world’s Gross Domestic Product (GDP).
The OTC derivatives account for 86 per cent of the amount and will lead to rise in use of exchange-traded and centrally-cleared derivatives.
Also speaking at the event, Chairman, Swaps & Derivatives Workgroup and FMDA President, Samuel Ocheho, said the workshop with the theme: Legal Documentation as Driver to introducing New Products and a Healthier Financial Market in Nigeria was organised by the Swaps and Derivatives Workgroup of the FMDA to sensitize people, members of the FMDA and other market operators on the need for hedging products and proper documentation in the market.
The International Swaps and Derivatives Association (ISDA) Africa Chairman, Brett Gallie and Partner at Clifford Chance, Derivatives and Structured Trades, Matthew Grigg were also at the event to support the Nigerian derivatives market.
Continuing, Onadele said that pension fund managers also needed to understand the impact of hedging on their operations, especially as interest rate that was 17% today could suddenly become 11% in the nearest future.
“The CBN brought naira settled OTC FX futures and now everybody is able to hedge and plan. As the commodities market in Nigeria grows, all of us will understand that playing vanilla derivatives is good for risk management. What we are preaching now is plain vanilla derivatives to protect the pension and the price,” he said.
According to Ocheho, FMDA is a partner in progress in developing the Nigerian financial and derivatives market, adding that the programme was supported by FMDQ OTC Securities Exchange to impact positively on the derivatives market.
“There is need to have proper documentation for all the products that we are doing in the financial market. In Nigeria, we do not want to lose revenue. One way to ensure that our oil price remains high is by creating a hedge product for the oil price. Most government doesn’t want to hedge because they believe the price is expensive. The level of adoption of hedging in Nigeria is still very low because most people do not understand why they need to hedge. I understand the reason is cost but hedging gives you a better way for planning,” Ocheho said.