Equity derivatives will signal Nigerian markets are moving to the next level  

By John Kavvouras, Director, GTI London Ltd.

A recent IMF report highlighted the need for Nigeria to diversify its economy away from oil and gas. Thereport outlined deficiencies in the economic environment which “are dampening long-term foreign anddomestic investment and keeping the economy reliant on volatile oil prices and production”.

The benefits of diversification from an oil-based economy to one with a greater breadth of markets andparticipants will require advanced domestic financial markets. As Nigerian exchanges mature, inevitablyderivative instruments will become an integral part of this development. A derivative instrument is a financialproduct with a market value that is derived from an underlying asset or basket of assets. Derivatives can serveas a risk management instrument as well as a leveraged vehicle for speculators. The availability of derivativeswill inevitably increase international capital flows and deepen Nigerian financial markets.

Many Government policies have been directed at promoting the agricultural and mining sector. It has becomerecognised that derivative instruments will play a key role in the expansion of domestic commodity markets.

Derivative instruments have also been introduced to help in dealing with uncertainty and volatility inherentin the domestic currency markets. To this end, FMDQ has been offering derivative instruments based oninterest rates and currency to Nigerian financial market participants. These initiatives are laudable and shouldbe supported by the financial services community.

Up to this point, the focus has been on foreign exchange, interest rates and commodity-based derivativeinstruments. These are all vital components of a functioning market economy, but the one area with little or nodiscussion is equity-based derivatives. An equity derivative is a class of derivatives whose value is derivedfrom one or more underlying equity securities. The most common equity derivatives are options and futures.

Inflows of portfolio investment from foreign investors are key to the growth and development of Nigeria’sdomestic economy. However, the IMF reports that “Non-resident holdings have been rising … … but startedto reverse recently… Record stock market gains have been wiped out in 2018 amidst increasing portfoliooutflows.” Any additional financial products offered by the Nigerian Capital Markets which would helpcounter the outflows should be explored. What has been overlooked is the attraction of equity-basedderivative instruments to international investors. A functioning equity-based derivatives market will provideadditional risk management capabilities to market players and help to promote more active participation offoreign investors in the Nigeria equity markets.

According to the Bank for International Settlements, “Only 10% of global derivatives turnover is in contractsdenominated in the currency of an emerging market economy (EME), much lower than the share of theseeconomies in global GDP or world trade.” Clearly, the potential for growth in derivatives for emergingmarket economies is enormous. The current initiatives by various Nigerian financial market participants inthis sector are very promising and GTI can provide additional expertise to help bridge any gaps. Financialservices firms, as well as Nigerian corporations interested in discussing how they can hedge their investmentportfolio, derive additional income from their existing equity holdings or use derivative instruments tospeculate on Nigerian stocks can contact GTI London at admin@gti.london

• Kavvouras has extensive experience in dealing with OTC derivative instruments inboth Europe and North America. He has been a financial service professional for over 20years serving in various executive management positions in the United States, Canada andthe United Kingdom. He holds a BA (Hons) from McGill University and the CISICertificate in Derivatives from the Chartered Institute for Securities & Investment.