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As part of moves to
discourage currency speculation and protect the value of the national
currency, the Central Bank of Nigeria (CBN) is creating a currency
futures market.

A currency futures
markets trade futures contracts, which specify that the underlying
index, in this case, the US dollar, will be bought or sold for a
specific price, on a specific date, in the future (known as the
expiration date).

In the recently
released guidelines, ‘Foreign Exchange Derivatives and Modalities for
CBN FX Forwards’, the regulator hinged this on its mandate to develop
the Nigerian financial markets and assurance of financial system
stability.

“The reforms cover
products, practices, regulation and supervision. The objective of the
CBN is to make our financial markets global, organised, liquid and
diversified. The development of the financial markets will enhance the
transmission of the monetary policy and minimise the risk to financial
system stability,” the CBN said.

Maximum tenor

The guidelines
states that, “The maximum tenor allowed for FX Forwards, and by
implication FX Swaps and Cross-Currency Interest Rate Swaps, is now
extended to five years. Authorised Dealers may seek specific approval
for longer tenors.”

The guidelines
stated that authorised dealers are allowed to offer to their customers
and the modalities under which the CBN intends to boost the trading
liquidity in these products. “Authorised dealers are expected to be
professional in their conduct in ensuring the efficient operations of
the Foreign Exchange (FX) market. Also, unprofessional conduct by the
staff of the Authorised Dealers shall not be tolerated.”

According to the
CBN, the approved hedging products are FX Options, Forwards (Outright
and Non-Deliverable), FX Swaps, and Cross-Currency Interest Rate Swaps.

CBN governor,
Lamido Sanusi, hinted last October that he would consider introducing
products that would discourage currency speculation.

“Part of what we
are trying to do in the Central Bank is introduce a forward market so
that people can hedge that risk and then don’t feel any urge to
pre-liquidate outstanding dollar exposure,” Mr. Sanusi told Reuters.

Frontloading

According to him,
there were indications that some people might be frontloading some of
their dollar obligations, resulting in the huge demand for foreign
exchange, a situation that would be ameliorated by a currency futures
market. The naira has shed 0.77 per cent since the beginning of the
year, closing yesterday at N150.31, compared to 149.16 at which it
closed last year at the official market.

The naira traded at N126.48 per dollar at end-December 2008.

According to the
CBN guideline which was released yesterday, the minimum allowable bid
amount by authorised dealers for each tenor shall be $500,000.

“The maximum spread
of 50 kobo is allowed on the sale of forwards with less than three
months tenor, whilst 75 kobo is allowed for tenors above three months.”

To further
discourage speculation in the futures market, the guideline disallows
forwards bought from the CBN to be traded in the inter-bank market.

“FX purchased from
the WDAS-SPT cannot be sold forwards to customers, as it must be
utilised within five (5) business days after settlement as per the
WDAS-SPT guidelines.”

Also, as incentive to encourage participation, “Forward contracts
will be recognised as off-balance sheet exposures in the books of
Authorised Dealers. Authorised Dealers are expected to bid on behalf of
their customers.”