The Central Bank of Nigeria (“CBN”) recently released new guidelines on Foreign Exchange Derivatives and Forwards that Authorised Dealers are permitted to offer to their customers and the modalities under which the CBN intends to boost trading liquidity in these products (the “Guidelines”).
The Foreign Exchange Monitoring and Miscellaneous Provisions Act of 1995 defines Authorised Dealers as “banks licensed under the Banks and Other Financial Institutions Act, and issued with a licence to deal in foreign exchange”. The Guidelines are aimed at deepening Nigeria’s inter-bank foreign exchange and making Nigeria’s financial markets “global, organized, liquid and diversified”.
Four products were approved under the Guidelines. These are Forex Options, Forwards (Outright (which were previously approved by CBN) and Non-Deliverable), Forex Swaps and Cross-Currency Interest Rate Swaps (“CCIRS”). Authorised Dealers are now allowed to offer European-styled forex call and put option contracts to their customers and in the inter-bank market. The CBN has tied trading in the products to underlying transactions as the Guidelines provide that hedge transactions with customers must be backed by trade (visible and invisible) transactions.
Non-Deliverable Forwards (NDFs) are now permitted in view of the need to provide hedging opportunities for customers and investors with long-term investment perspectives as well as provide customers with a choice as to where to bank and where to hedge, The maximum tenor allowed for forex forwards, forex swaps and CCIRS is five years. Specific approvals must be sought for longer tenors.
The CBN may also grant approvals for qualifying Authorised Dealers to engage in Forex Options. Details of the approval process are to be released at a later date.
The Financial Policy & Regulation and Banking Supervision Departments of the CBN will subsequently be developing detailed prudential guidelines that will regulate Foreign Exchange Options. The prudential guidelines will cover qualifying criteria, limits, capital adequacy charge, spot-hedge position limits (in the absence of a developed inter-bank options market), market risk management standards and internal controls standards.
The CBN anticipates that foreign investors’ interest in financing infrastructural gaps in Nigeria. To this end, it is therefore supporting Authorised Dealers with Cross-Currency Interest Rate Swap (CCIRS) trading liquidity. The CBN will be willing to provide hedges for CCIRS to support projects with long-term foreign exchange exposure. All CCIRS requests are to be made to the Financial Markets Department (FMD) of the CBN and must be project-backed. The FMD will subsequently issue detailed guidelines on the CCIRS structures offered by the CBN.
A Nigerian Master FX Agreement (NMFA) shall be executed by any Authorised Dealer that intends to engage in CBN Foreign Exchange Forwards.
Specific transactions shall be backed by confirmations duly executed by relevant signatories of Authorised Dealers; and
Authorised Dealers shall also execute Master FX Agreements with their customers.
The Guidelines also state that the minimum allowable bid amount by an Authorised Dealer for each tenor offered shall be $500,000.00 (Five Hundred Thousand Dollars) and the CBN reserves the right to adjust the amount sold on each tenor.
The Guidelines also mandate that all forex forwards purchased from the CBN shall not be transferable in the inter-bank market and that Authorised Dealers are required to bid on behalf of their customers.
Furthermore, Authorised Dealers are required to ensure that their operating accounts are adequately funded on the maturity dates of the forward purchase. A one percent (1%) commission shall be calculated on the forward rate and debited on the settlement date. Maturity dates shall be set at spot date (T+2) plus one month, two months or three months depending on the tenor of the relevant forward purchase contract.
Finally, the Guidelines provide that forward contracts will be recognised as off-balance sheet exposures in the books of Authorised Dealers.
What the Guidelines Do Not cover
The Guidelines do not cover the following in respect of which a number of foreign investors had expressed interest in dealing with Nigerian counterparties including:
(a) American-styled options;
(b) “Exotics”: The Guidelines do not cover exotic options. Given the rudimentary level at which the Nigerian forex market currently operates, this is understandable;
(c) “Synthetics”: Synthetic CCIRS are not presently covered under the Guidelines. Accordingly, the principal, and not notional amounts of both the Nigerian Naira and the [United States Dollars] are required to be exchanged. We are concerned that the Guidelines limit trading to only the United States Dollars and expect the options to be expanded in future;
(d) Mark-to-Market Currency Swaps;
(f) Forward Rate Collar Swap; and
(g) Total Return Swaps (“TRS”): Given the limited scope of the Guidelines, equity and Debt TRS are not covered.
It is hoped that the Nigerian Securities and Exchange Commission will take a cue from the CBN and develop detailed regulations covering non-foreign exchange derivative products not covered by the Guidelines.
The Guidelines supplement the relevant provisions of the 2006 CBN Foreign Exchange Manual relating to dealings by Authorised Dealers in Foreign Exchange Forward and Foreign Exchange Swap contracts.
In conclusion, the release of the Guidelines clearly signposts that hedging in forex derivative products is officially now recognised in Nigeria’s foreign exchange market. It is expected that foreign investors looking for alternative investment outlets will draw some comfort from the Guidelines and that the same will positively impact both the Nigerian forex market and the project finance market, given the introduction of CCIRS. Nigerian manufacturers, importers and the subsidiaries of multinational corporations operating in Nigeria also rank among the likely beneficiaries of the introduction of the Guidelines.
Nkem Ekwere is of the law firm, Jackson, Etti and Ed