African banks taking dollar-denominated loans are being urged to hedge the facility against the risk of currency fluctuation.

“Anyone that takes foreign currency loan should hedge, that is the opportunity the Central Bank of Nigeria (CBN) has provided,” said Bola Onadele, chief executive of Nigeria’s largest securities exchange the FMDQ, who spoke at a financial markets workshop in Lagos. “The rates are low in dollars, so you are tempted to borrow in dollars at 4% instead of borrowing in naira at 20%.”

He outlined the purpose of hedging/derivatives as primarily risk management instruments enabling participants to price and transfer financial risks such as market/price, foreign exchange and interest rate risk. Hedging reduces the risk of exposures to unforeseen circumstances, Onadele added, as a risk management strategy used in limiting or offsetting probability of loss from fluctuations in the prices of commodities, currencies, or securities.

The benefits of derivatives in improving risk management and business planning included increased credit to critical sectors of African economies to drive growth, greater capital flow from foreign portfolio investors, increased liquidity in the system and promoting market efficiency and sophistication as well as financial system stability.

Widespread usage

Onadele noted that 92% of the world’s top 500 companies manage their price risks using derivatives, adding that notional principal of derivatives increased by 642.17% in 20 years, from $93.02 trillion in 1998 to $690.37 trillion in 2018, or over eight times the world’s gross domestic product (GDP).

Over-the-counter (OTC) derivatives accounted for 86% of the figure and would lead to a rise in the use of exchange-traded and centrally-cleared derivatives.

Onadele said that pension fund managers also needed to understand the impact of hedging on their operations, especially as interest rates could be reduced sharply in the near future . Nigeria has just cut its key rate for the first time in more than three years, from 14% to 13.5%.

“The CBN brought naira settled OTC FX futures and now everybody is able to hedge and plan. As the commodities market in Nigeria grows, all of us will understand that playing vanilla derivatives is good for risk management. What we are preaching now is plain vanilla derivatives to protect the pension and the price.”