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Futures market: The new game in town

By Editor
13 July 2016   |   12:58 am
The Central Bank of Nigeria (CBN), in a period of seven days, re-opened the interbank market for foreign exchange transactions, followed by the launch of the OTC Futures market for the same foreign exchange transactions.


The Central Bank of Nigeria (CBN), in a period of seven days, re-opened the interbank market for foreign exchange transactions, followed by the launch of the OTC Futures market for the same foreign exchange transactions.

The FMDQ- a self- regulatory organisation, known for organising and providing oversight on the Over-the-Counter market in the Nigerian capital market, was also unveiled to serves as the platform through which trading will be conducted.

We expect that this development will throw up exciting possibilities. We note that Futures contracts by their nature serve as a hedge against uncertainties.

For Nigerian end-users of forex, particularly businesses who need foreign exchange to import raw materials and machineries, the market provides the opportunity for them to hedge against volatility risks that can be associated with the Naira exchange rates.

Future contracts guarantee quantity and rates at a future date. For instance, by locking into a six-month futures contract at the market rate of N250/$ with a dealer, the rate will be guaranteed at the end of the period of six months.

Upon maturity, if the spot rate depreciates to N300/$, the needed foreign exchange will be purchased at that spot rate while the CBN, the underwriter in the case of the Naira, will repay the Naira difference to the end user.

Conversely, if the end-user locks into a futures contracts and the Naira spot rate appreciates to N240/$ upon maturity, the end-user will be required to pay the difference to the CBN.

Thus businesses and other users of forex can now afford to plan their businesses operations without having to worry about daily movements in the Naira exchange rates.

In all, the combination of the new single market structure and the historical flag off of the OTC FX Futures market will add impetus to Nigeria’s economic growth and the deepen her financial market. Without a doubt, this will help improve business confidence and promote trade relations between Nigerian businesses and their foreign partners.

Secondly, we expect that the usual mad rush to obtain and stockpile FOREX at all costs and the uncertainty it brings will naturally disappear.Moving forward, we anticipate that foreign investors, who have largely stayed out of the Nigerian market on account of the foreign exchange restrictions imposed by the CBN, will be encouraged by the establishment of the single market determined exchange rates. It is also expected that there will be improved access to foreign exchange for the repatriation of investments proceeds.

Liquidity constraints and confidence crisis
Barely three and two weeks respectively have passed since the re-opening of the inter-bank forex market and the launch of the OTC Futures market. While it is too early to assess the effectiveness of the two markets, we note that the success of the new foreign exchange market architecture will largely depend on investor confidence which will in turn drive liquidity.

At the moment, we believe the market appears to be suffering from liquidity challenges induced by confidence deficit. The level of confidence reposed in the market by both domestic and foreign investors and participants remain at best tepid. Investors and potential suppliers of forex have largely remained on the sidelines.

As a result, the Central Bank of Nigeria has become and, unless confidence is bolstered, would likely remain the single major supplier of FOREX in the market in the short term.

Secondly, we note that the current structure of the market follows from the structure of the Nigerian economy. The economy is still substantially under-diversified with crude oil exports only the major source of foreign exchange earnings.

Again, foreign capital inflow and the demand for Naira assets have been under tremendous pressure partly due to slowdown in the economy, inappropriate pricing of the Naira and low investment outlets.

Thus, the Nigerian government should, as a matter of urgency, begin the implementation of the much needed structural reforms which would fundamentally change the structure of the economy away from over dependence on crude oil to other priority areas particularly agriculture and solid minerals.Nigeria needs to export more to other countries across various ranges of products, while simultaneously encouraging the inflow of foreign direct investments.

In the immediate term therefore, liquidity is the main constraint. This is especially the case because there is generally very low business confidence in the economy. It is made worse by the lack of economic reforms and policies that will drive investments in the country.

As a result, while the traditional remittances supply will remain, and significant portfolio flows may return at the back of the establishment of the market, it remains to be seen when foreign direct investment (FDI) will start to rise again.

Nigeria thus needs a variety of investment outlets in order to improve the supply of foreign exchange. In addition to investment outlets that will drive supply, Nigeria will also have to deal with acquiring the skills required for an efficient market, both from the regulatory and participants perspectives.

On the 20th of June 2016, the Central Bank of Nigeria (CBN) formally launched the new market for foreign exchange transactions. This process sees the elimination of the two-market structure that had been in place into a single market structure, which is hosted at the inter-bank market.

Effectively, Naira exchange rate against other major currencies is now market determined, eliminating the official exchange rate of N197/USD. The new FOREX market is designed to enhance liquidity, access, and promote transparency.To ensure liquidity, the CBN has also introduced Primary Market Dealers (PMD) under revised set of policy guidelines. As a result of the stringent capital requirements, much of the PMDs so far licensed are commercial banks with about 15 banks reportedly given the nod by the apex Bank.

Furthermore, the CBN, in an unprecedented fashion swiftly moved to clear the backlog of unmet foreign currency demands of $4.02 billion through a Special Secondary market Intervention Sales effectively removing the single biggest immediate headwind for the market.
• Culled from Time Economics

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