The NGX, shareholders and inflation derivatives
BY: SOLA ONI
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. By this innovative development, 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 Counterparty (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 Licence Holders.
The elated chief executive officer, Nigerian Exchange Limited, Temi Popoola, could not hide his joy as he said: “I would like to specially acknowledge the work that was done under the previous management of the Exchange, led by Mr. Oscar N. Onyema OON, whose contributions have formed the foundation of our present gains and accomplishments made manifest through the launch of NGX ETDs market. 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.”
Corroborating him, the chief executive officer, NG Clearings, Mr Tapas Das said, “The launch of the derivatives market in Nigeria is a testament to the maturity of our market, a sign that the market has come of age and is ready to transition into a new era. The risks that come with the derivatives market will be managed through NG Clearings’ robust technology…”.
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.
On the other hand, 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.
The management of NGX under Oscar Onyema and now, Temi Popoola, should be commended for pushing the project of Derivatives trading to its logical conclusion. But successive management of NGX has always demonstrated corporate foresight. Over two decades ago, the management of The Exchange under Professor Ndi Okereke-Onyuike had commenced the process of demutualisation of the market. The demutualisation was finally consummated in March last year, under the Onyema-led management. Similarly, Okereke-Onyuike-led management had earlier seen the need to commence trading in derivatives instruments for enhanced risk management. The then management set up a Derivatives Department headed by a general manager and commenced training of The Exchange’s staff. An education visit was later organised for some stockbrokers to the University of Reading, United Kingdom, where they were exposed to trading in derivatives instruments through simulation.
Similarly, Chartered Institute of Stockbrokers (CIS) created capacity building for trading derivatives instruments through its Professional Examinations and regular training workshops for stockbrokers. There is no gainsaying that the likes of Ade Omolehinwa, Dr John Osuoha, Isiaka Atanda, the immediate past Registrar of the Institute, Adedeji Ajadi, amongst others, have distinguished themselves in capacity building for derivatives trading in Nigeria.
As I put in my article titled: “Time for Derivative Trading in Nigeria”, published by many national dailies and prominent Online Platforms in early March, 2021, 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 stock market has been long positioned for derivative trading. Apart from having the basic infrastructure, the spot market for underlying assets is as old as the history of the Nigerian economy.
As a normal market, NGX 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 quandary. Recently, news broke that the United Kingdom’s inflation has skyrocketed to a new 30-year high 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, the 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. The apex bank has consistently retained the monetary policy rate, cash reserve ratio and liquidity ratio to sustain price stability and growth in an atmosphere of stagflation.
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 assumptions of inflation and monetary and fiscal policy. This may jeopardise 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 these hedging instruments. At this point in time investors require a knowledge of Inflation Derivatives. This type of derivative provides opportunities for investors to minimise potential risks of rising inflation. By investing in inflation derivatives, an investor can speculate future trends of inflation as a risk aversion measure.
According to Investopedia, the most common form of inflation derivative is an inflation swap. This allows an investor to secure an inflation-protected return relative to an index, such as the Consumer Price Index (CPI). There is a Zero-Coupon Inflation Swaps which gives an investor an option of trading the instrument over-the-counter before maturity. While inflation can erode a portfolio’s real value, inflation derivatives are a hedge against the risk. Inflation derivatives can be deployed for a wide range of products and they are more cost effective. Individuals can participate in the price movement of an underlying asset through inflation derivatives.
However, opinions of shareholders differ on the launch of NGX ETDs. They all agreed that derivatives trading is necessary. But while many hailed the launch as one of the best initiatives in the market in recent time, some believe that a lot more should be done to encourage retail investors to take advantage of the derivatives market to manage share diminution.
“The brokerage firm community is not ripe for ETD. They are currently struggling with native equity market, let alone the derivative market. More training is required for them. Derivative market is prone to heavy risk and our brokerage firms, who are supposed to advise us, lack the financial muscles for managing such risk. They should create more products through ETFs first, which have lesser challenges than ETD,” said a concerned shareholder.
Sola Oni, an integrated communications strategist, Chartered Stockbroker and Commodities Broker, is the Chief Executive Officer, Sofunix Investment and Communications. You can reach him at onisola2000@yahoo.com
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