By Babajide Komolafe
The Central Bank of Nigeria (CBN) has approved derivative products for the foreign exchange market to enable operators and end-users hedge against losses arising from exchange rate fluctuations.
A derivative is a financial instrument or contract that is attached to another financial instrument or asset, and the purpose is to provide hedge or mitigate the risk of loss due to changes in the price of the underlying asset.
On Monday, the apex bank announced the approval of foreign exchange Options, Forwards, Swaps and Cross- Currency Interest Rate Swaps (CCIS).
“The approved hedging products are FX Options, Forwards (Outright and Non-Deliverable), FX Swaps and Cross-Currency Interest Rate Swaps”, it said in a circular to all authorised dealers titled, “Guidelines for FX Derivatives and Modalities for CBN FX Forwards”.
“Authorised dealers are now allowed to offer European-styled FX call and put option contracts to their customers and in the inter-bank market.
“All hedge transactions with the customers must be backed by trade (visible and invisible) transactions.
“The CBN shall grant approvals for Authorised Dealers that qualify to engage in Options. Details on the approval process shall be released in due course,” it added.
Foreign exchange Forwards refers to sale or purchase of foreign exchange for delivery at a future date.
Foreign exchange swap involves buying (selling) a currency at the spot market and selling (buying) it at the forward market.
Foreign exchange options contract conveys the right but not obligation to sell (buy) a given quantity of foreign exchange at a given date.
The contract also specifies the price or exchange rate at which the currency can be bought or sold.
Put options conveys the right to sell while Call options conveys the right to buy.
The CBN said it would also be offering to and buying from the banks foreign exchange Forwards with the aim of boosting liquidity in the Forwards market.
“The CBN intends to offer to authorised dealers short-tenored FX forwards to boost the trading liquidity in hedging products.
“With a deep forward market, it is believed that the demand for foreign exchange will smoothen out and accelerate demand in reaction to anticipatory depreciation in Naira will reduce.
“The CBN shall also be prepared to purchase forwards from Authorised Dealers. CBN forward rates shall be advised from time to time.”
Forward contracts will be recognised as off-balance sheet exposures in the books of authorised dealers.
Banking Supervision Department will be reviewing the set of returns submitted by the Authorised Dealers to ensure the hedged and un-hedged foreign exchange exposures in the system are appropriately captured.