have not yet had the expected impact on the Nigerian economy, .... the economy, that the Federal Government started trading Nigeria's debt in the secondary.
THE IMPACT OF DERIVATIVES TRADING ON THE NIGERIAN ECONOMY (1988-2001)
• ;e .
~ew
AMADI S. N. HARRYD. M. NGEREBO T. A . HARRISON F. ABSTRACT. Derivatives are fast revolutionizing financial markets the world over, and are becoming useful sources of increasing the depth and breath of capital markets in particular. Economic and financial derivatives are transforming economies, including the Nigerian economy. The study examines the relationship between the different forms of derivatives and their joint impact on the Nigerian economy during the period under study. The OLS regression model was used to test our null hypothesis. We discovered that derivatives have not yet had the expected impact on the Nigerian economy, though the potentials are high. The reason for this is more sociopolitical than economic. We recommends therefore that enabling socio-political and economic environment by created and the relevant regulatory institutions adopt a more liberal approach so as to realize the full potentials/benefits of derivatives.
INTRODUCTION Fairs organized in England and France in the early 12th century, provided merchants the opportunities to purchase or sell a certain amount and quality of trade items on a negotiated/specified date and at a certain fixed price. This is derivates trading and has generally today been applied to every aspect oflife. A derivative is an asset that derives its value from another asset (Rutledge,1995). They are sometimes called contingent claims because their claim is contingent upon the value of the underlying security (Levy 1996). The price of a derivative is linked to the price of the underlying set. Arbitrage maintains this link. Derivatives can be classified according to the type of trade; Exchange Traded Instruments, and instruments bought directly from the bank or financial institutions. They
Amadi S. N., Harry D. M, Ngerebo T. A. and Harrison F. are affiliated with the Department of Banking and Finance, Rivers State University of Science and Technology, Port Harcourt, Nigeria .
International Journal of Social and Policy Issues - Special Edition. © 2004 by The Development Universal Consortia. All Rights Reserved.
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International Journal of Social and Policy Issues - Special Edition.
are called over-the-counter (OTC) derivatives. Basically, there are four broad types of derivatives: swaps, options, futures and forward contracts. Swap is an agreement between two or more parties to exchange a sequence of cash flows over a period of time. It is considered to be a new type of financial security. Brown (1995) has stated that swaps can be likened to a portfolio of futures contract that involve multiple delivery dates. The most common types of swaps instruments are: interest rate swaps, currency swaps, trading swaps and assets swaps. The basic limitation of swaps is that dealers have to source for parties that are willing to transact thus making it an OTC transacts. An option is a legal contract, which gives its holder the right to buy or sell a specified amount of an underlying asset at a fixed or predetermined price. There are two types ofoptions, namely: the call option, which gives the holder the right to sell a specified quantity of an underlying asset at some period in the future at a predetermined price. Investors transact in options to speculate on the price movements of the underlying stock. Preferences for investment in options rather than stocks are for reasons of reducing transaction costs, avoid tax exposure and avoid stock market restriction. Option trading occurs in exchanges over-the-counter (OTC) and directly between buyers and sellers. The options market includes stock options, treasury bills, treasury bonds, commodities markets, currency options as well as futures options. A futures contract is a marketable obligation to deliver a specify. Forward contracts also involve an exchange of one asset for another while the price at which the exchange occurs is set at the time of the initial contract. It can thus be seen that every one has been involved in one forward contract or the other. Because of the importance of this type of security in recent times, this study becomes timely and relevant and seeks to examine how it can affect the economy of the country.
CONCEPTUAL FRAMEWORK Scholars have widely discussed the impact of derivatives trading on the economies of nations. From a study by the Financial Economist Roundtable, derivatives trading is seen as a highly useful risk-management tool for both financial and non-financial fim1s. From interest rates to physical assets, derivatives have made many positive impacts on firms. The prudent use ofderivatives has helped market participants guard against volatility, thus creating an enabling environment for job creation (Leach 1993). Derivatives reduce systemic risk by spreading the impact ofunderlying shocks among a larger set ofinvestors (Hentschel et al 1995). This is not to say that there are no dissenting views. The financial or capital markets in Nigeria are relatively well developed when measured by African standards. Today, there are over 88 banks, 180 stock brokerage finns , several issuing houses, dozens of other financial institutions, discount houses, insurance companies, a central clearing and settlement systems, two stock exchanges and an apex bank (the Central Bank ofN igeria) .
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Amadi et al
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The basic derivative products marketed by the financial institutions are the Debt Instruments from the Debt Conversion Programme which products are packaged by a Department (DMO) of the Central Bank of Nigeria, the Nigeria International Debt Fund (NIDF), the Global Depository Receipt (GDR) and Trading in Rights, which are traded in the Nigerian Stock Exchange. The debt crises that engulfed the nation in the 1980's led to the initiation of the Debt Swap and Debt Conversion Programmes. Debt swap involves the exchange of a country's foreign currency denominated debts by the holder, usually at a discount, with equity or local debt instruments in the debtor country. As part of the strategies for reducing the debt service burden, Nigeria has since 1983/84 embarked on debt restructuring and rescheduling with the London and Paris Clubs of creditors. Unfortunately, the relief sought through these traditional approaches has proved to be negligible. It is for this reason, coupled with the need to find new financial options to inject ' new money' into the economy, that the Federal Government started trading Nigeria's debt in the secondary market in 1988 (Danjuma 2001, Amah 2002). The Nigeria International Debt Fund is another strategy adopted by the government to reduce the debt burden of the country. Many countries have, in the 1980 's, .ernharked uoon the securitization of their debts. Securities financing has become an , . important element in domestic and global financial markets. The technique involves temporary exchange of securities, usually for other securities or for equivalent cash value the collateral) with an obligation to redeliver a like quantity of the same securities at a future date (Cedel Bank Com 2002). Nigeria's version of this, the NIDF, was set up in : 997 to pool together capital from sophisticated investors in order to invest in Nigeria's dollar denominated debt instruments (Nigeria Par Bonds and Promissory Notes). The aim is to allow Nigerian investors access to the returns currently enjoyed by many :.::::iternational investors who hold and trade in these instruments. These debt instruments a little percentage of Nigeria's total external debt, and are quite separate from the '..llk of the debt, which is owed to multilateral and bilateral agencies (example the
arisCl\lb). Nigeria is the only African country to have successfully completed a Brady Bond issue and has never defaulted on the semi-annual interest payment. A special purpose company called the Nigeria International Debt Fund Plc has been incorporated. The company issues a bond, which is broken down into investment notes, affordable by investors. The naira proceeds from the Fund are used to buy foreign exchange in accordance with CBN guidelines. The foreign exchange is used to purchase Nigeria debt obligations in the international market, operated by the International Custodian responsible for the safekeeping of the underlying assets of the Fund. Twice a year coupon payments are made on the net income received by the fund over the preceding six months on the underlying debt obligation of the Fund.
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International Journal of Social and Policy hmes - Special Edition.
Twenty five percent ofthe net income is reinvested in order to increase the value of investors' holdings, while the remaining seventy five percent is paid out as coupon payment. The International Custodian, acting on the instruction of the manager, pays the total amount of the coupon due to all the investors on a semi-annual basis, either at the prevailing competitive market-based rate at the time of payment or in dollars into domiciliary accounts (NIDF Plc 2002). At the expiration of the life of the fund that is, 24 years, the assets of the fund will be liquidated at market value and the proceeds paid to the investors. The benefits of the Nigerian International Debt Fund, include, among others shares that are held by the depository bank or by a local custodian bank acting as the depository bank agent. There are several types of Depository Receipts among which are: the Global Depository Receipt, the European Depository Receipts and the American Depository Receipts. Nigeria's only experience in Depository Receipts is the UBA (United Bank for Africa) Global Depository Receipt Programme. The programme was borne out of request from international fund managers and investors who were interested in investing in Nigeria. By the turn of the new millennium, foreign investors held about 407 million shares in the bank. It should be noted that the sale ofshares to international investors does not constitute a change in the ownership structure of the investing companies (Bello-Osagie 1999). The advantages of the Global Depository Programme are many. They include capital provision, increasing the size ofcapital base, flexibility in financial instrument, globalization of transactions increased viability and prestige and better corporate governance.
RESEARCH METHODOLOGY Data were collected from the Central Bank Annual End of Year Reports and Statements of Accounts for the Debt Conversion Proceeds and GDP at 1984 constant market price. The Nigerian Stock Exchange Facts Book provided the source for data in Nigerian International Debt Fund and Traded Rights. The data on Global Depository Receipt was collected from the UBA Annual Report and Statement of Accounts. (These empirical data are at appendix). Our time frame is 14 years ( 1988-200 l ). Analysis was conducted to determine the impact of the Debt Conversion Proceeds on the Nigerian economy. The relationship between the Nigeria International Debt Funds and the Gross Domestic Product was determined for a period of5 years (1997-2001). Traded rights and its impact on the gross domestic product was for a period frame of 4 years ( 1988200 l ). The UBA Global Depository Receipts in 1999 was an on-off transaction.The Ordinary Least Squares (OLS) method was used to test our null hypotheses Our computational device was the SPSS (Statistical Package for Social Sciences). A linear regression model of the type : Y = a+ bx. (a) Provisions of a visible and transparent operation in which Nigerians can invest in their own sovereign debts to assure the international investing community that
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Amadi et al
Nigerians have faith in their own economy. (b) Payments made on the underlying debt are repatriated into Nigeria, and made available to local investors.
--e
(c) Since the returns on the investment are dollar-linked, investors can use it to hedge against any future devaluation of the naira for the life of the Fund. (d) Tax exemptions arising from trading on these government securities help to shore up the income of investors. (e) The yield on the underlying instruments is high in U.S. dollar terms and help to attract investors by virtue oflisting and trading on the Nigerian Stock Exchange.
-md
_ =.ross -:ghts
9 -
Rights trading- a type of derivative trading is one ofthe initiatives of the Nigerian Stock Exchange and the Securities and Exchange Commission in Nigerian, to broaden and deepen the operations of the Nigerian capital market. Trading in rights is a shortterm transaction, involving buying ofshares is usually specified in terms of the right to buy a given number of new shares in a company relative to the number of shares already held example, the right to buy one new share for every two ah-eady held. Though sometimes used interchangeably, it is different from warrants that confer a long-term right to buy the shares of the company (Edun, 1998). The first Right Trading in Nigeria was in July 1998 (Alile, 1998). The promulgation in 1995 ofNigerian Investment Promotion & Commission Decree (NIPC) and the Foreign Exchange Monitoring and Miscellaneous Provision (FEMMP), redefined the businesses in which foreigners could participate to encompass all businesses except 2 or 3 for national security reasons. Specifically section 26 of the FEMMP decree empowered foreigners to invest in the securities of companies quoted on the Nigerian Stock Exchange or make private placements. This measure led to farreaching reforms by the Nigerian Stock Exchange including internationalization. This primarily opened the gateway for the establishment of the first depository receipts initiated by UBA. Depository Receipts are internationally traded securities linked to the underlying shares oflocal companies. They are negotiable receipts issued by a depository bank in multiples of an issuer's company used to establish the relationship between the independent variables: Debt conversion proceeds (DCP), Nigerian International Debt Fund (NIDF), and Traded Rights. And the dependent variable, Gross Domestic Product at constant and current prices). The estimated equation for DCP and GDP is: GDP
=
94 .337 + 2.771 DCP .. .. . .. . . . . . ... . . .. . .. ( 1)
The result showed that the proportion of variation in the dependent variable Y, at can be explained by the independent variable X, that is, the value of the coefficient .--determination (r ), is 0387 or 39%. Ther is 0.622 or 62% and anANOVA of0.18 -as considered significant at P > 0.05 . A t-value of2 .751 is greater than the t-critical
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International Journal of Social and Policy Issues - Special Edition. F
value of2.179. This shows that the coefficient ofthe independent variable is significant at 5% level of significance. The estimated equation for NIDF and GDP is: GDP= 3029.9289 + 1090.653 (NIDF) The implication is that given the constant 'a' (3029.928) and 'b' (1090.653), a one-unit increase in NIDF (X) will result in a 1090.653 unit increase in GDP (Y) . The proportionate reduction of total variation associated with the independent variable NIDF (coefficient of determination r2 ) is 67%. A Second Approach of Weighting the NIDF on the stock market capitalization was adopted. We consider that since the NIDF is a stock that is traded in the stock market, its impact on the gross domestic product should not be direct but act as a covariance to the stock market capitalization. Eighty-three (83 % ) percent of the variance in GDP was accounted for by the NIDF. Sixty-nine percent (69%) of the variation in NIDF is explained by the DCP and is the coefficient of determination r . T-values for both approaches were 2.455 and 2. 600 respectively. This leads to the acceptance of our null hypothesis with t-critical ofJ.182 in aP > 0.05 for a 2-tailed test. The estimated equation for Traded Rights (TR) and GDP is: )
GDP = 3110, 158 + 2061.007 (TR) The coefficient of determination (r) is 0.987 (99% ), which is the propo1tionate variation that can be explained by the independent variables, (Traded Rights). Again, we consider that traded rights are stocks traded in the stock market, hence, it should be weighted against the stock market capitalization before evaluating its impact on the national economy. Both approaches showed ANO VA results of0.007 and 0.006 respectively, with t-value of12.245 and 13.314 against t-critical value of 4.303 , see appendices 57). A simple proportion/ratio analysis was used to show the contributions of GDR transaction to the national economy with GDP as proxy. The result was very negligible (0.00006).
DISCUSSION Our analysis resulted in a rejection of our null hypothesis for DCP and GDP while the null hypotheses were accepted for the Nigeria International Debt Fund and Gross Domestic Product, Traded Rights and the Gross Domestic Product and the Global Depositary Receipts and the Gross Domestic Product. The rejection of the first null hypothesis reveals that the higher the proceeds from debt conversion, the greater the impact it will have on the economy. This therefore suggests that, more efforts should be made to convert our foreign debts through auctioning. External debt servicing creates leakages in the domestic economy. Debt swap has also encomaged foreign capital inflows for investment and as grant. Projects financed through this programmes as at December 2001 stood at 200; made up of 54 new projects and 146 existing projects, either expanded or recapitalized.
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A madi et al
J
The second null hypothesis, which states that there is no significant relationship between the Nigeria International Debt Fund and the Gross Domestic Product, was accepted. It is on record that the stock has been bearish, as it has been selling below the quoted market price ofN8250. Currently, it sells at N704 7. 00. The fall in price is partly due to political instability in the country and poor enlightenment about this instrnment. Many are not aware of the benefits accruing from this Nigerian stock, which has a dollar-dominated return on investment. Results of the third null hypothesis also confirm that there is no significant relationship between traded rights and the gross domestic product. Derivatives trading used in other countries for hedging and speculation on investments have not moved in the same direction as in Nigeria. The volume of rights traded on the floor of the Nigeria Stock Exchange is very slim. Rights Traded between 1998 and 2001 represented only 5% of new issues. The result of the simple proportion between the UBA GDR and its contributions to the National economy was very insignificant at 0.0006. However, it can be argued that if an on-off transaction could yield this, multiples of such transactions will be significant for our country.
CONCLUSION Unlike most of developed countries, Nigeria lags behind in the use of derivatives for managing :financial structures. Countries and multinationals have been ab le to manage foreign debt, interest rates, modify balance sheet items, and cash flows , change the nature of assets and liabilities. They have used derivatives to modify debts as well as enhance and protect their portfolios. Many have expressed fear over derivatives trading due to the Baring Bank episode of 1995. But Harrison and Azubuogu (2001) are of the view that Baring Bank collapse was as a result of inept control of funding, credit and market risks and back door dealing. Worthy of note however, are the steps the Nigerian Stock Exchange is taking to deepen the market for derivatives trading. The move forwards the establishment of Real Estate Investment, Oil and Gas Investment and Exchange Traded Funds will definitely impact positively on the Nigerian economy.
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REFERENCES Alile H. I. (1998), Improving the Depth of the Nigerian Capital Market: the Role of Derivatives. Security and Exchange Commission and the Nigerian Stock Exchange Conference on Trading in Rights. Amah J.P. (2002), Central Bank of Nigeria, Debt Conversion Secretariat Abuja, Educational Paper. Bellow-Osagie H. (1999), The UBA Global Depository Receipt and its Impact on the Nigerian Capital Market.~ Paper Presented to the Nigerian Stock Exchange, Lagos.
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International Journal of Social and Policy Issues - Special Edition.
Brown K . C. and Donald J . S. (1995), Interest Rate and Currency Swaps. A Tutorial Charlottesville, VA: The Research Foundation of the Institute of Chartered Financial Analysis, 109-1 1Opp. Cedel Bank (2002), http://www.cedelbank. com.htm Danhuma S. A. (2002), Central Bank ofNigeria, Debt Conversion Secretariat Abuj a, Educational Paper. Edum 0. A. (1998), Improving the Depth ofthe Nigerian Capital Market. The Role of Derivatives. Security and Exchange Commission Conference on Trading in Right. Harrison F. and Azubuogu J. I. (2001), A Stand Off the Barings Bank Experience as a Classic Case of Inept Risk Analysis and Management Studies Vol. 2 No. 1 Springfield Publishers, Owerri. Hentschel F. and Azubuogu J. I. (·1995), Controlling Risks in Derivatives Market. The Journal ofFinancial Engineering. Leach J. A. ( 1993 ), Statement on Derivatives. Federal Reserve Board Washington. Levy H . (1996), Introduction to Investment. South Western College Publishing, Cincinnati-Ohio. NIDF (2002), Working Paper on the Nigeria International Debt Fund, Lagos . Rutledge P. and Bob B. (1995), A Brief Guide to Financial Derivatives, Pennyslavania Securities Commission, Pennyslavania.
APPENDIXl Table I : Proceeds of Debt Conversion and Gross Domestic Products Year
DCPX
GDPY
GDP DIFF
AT 1984 Constant M arket Price
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
0.182 0.807 1.044 0.745 1.326 0.606 0.312 3.894 9.5 11 7.345 5.085 5.674 5.886 2.131
78.127 83.731 90.613 94.910 98.211 100 .015 101.416 103 .627 107.614 111.101 113 .722 116.716 120.590 123 .761
15.120 20 .724 27 .606 31 .903 35 .205 37.008 38.409 40 .620 44.607 48.09 50 .715 53 .709 57.583 60 .754
Source: Central Bank ofNigeria Annual Report and Statement of Accounts. Various lssues, GDP-200 1Financial Standard Vol.-July 2002.
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Amadi et al
APPENDIX2 Table 2: Showing NIDF Transaction on the Nigerian Stock Exchange, Stock Market Capitalization and the Gross Domestic Product. (Figures in billion) Year
NIDFX
STMKCAP
1997 1998 1999 2000 2001
0.256 0.252 0.183 0.594 0.504
276.56 256.94 299.92 473.00 645.00
GDPY Current Market Price
3127.90 3272.17 3377.33 3614.28 3709.14
Source: NIDF STMKCAP: Nigerian Stock Exchange, Summary of Transactions, Various Issues GDP; 1997-2000 Central Bank of Nigeria Annual Report and Statement of Accounts. GDP 2001 Financial Standard Vol.- July 2002.
APPENDIX3 arua
Table 3: Rights Traded, ·stock Market Capitalization and Gross Domestic Product (Figures in N billion) Year
Tradergh
STMKCAP
(X)
1998 1999 2000 2001
0.090 0.116 0.252 0.287
256.94 299.92 473.00 645.00
GDP (at Current Price) (Y)
3272.17 3377.33 3614.28 3709.14
Source: Traded Rights and Stock Market Capitalization I 998-200 I Nigerian Stock Exchange, Annual Performance Reports, Various Issues . GDP: 1998-2000, Central Bank of Nigeria Annual Report and Statement of Accounts. 2001: Financial Statement Vol. Jul y 2002.
APPENDIX4 Table 4: UBA Depository Receipt, Capital Reserves and Gross Domestic Product (figures in N billion). Year
GDR
1999
0.204
Capital Reserves
Current Price
105.3
3377.33
-
Source: GDR. UBA PLC Nigeria J999 Annual Report and Accounts, Capital and Reserves of Financial In stitutions in Nigeria from Central Bank a/Nigeria Annual Report and Statement ofAccounts (I 999:90-96). GDP-Central Bank ofNigeria, Annual Report and Statement ofAccounts, (! 999: I I 6).
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International Journal of Social and Policy Issues - Special Edition.
RESULTS OF REGRESSION ANALYSIS APPENDIXS b
Model Summary Model 1
R
RSquare
622a
.387
Std. Error of the Estimate
.336
11.01308
b
Model Summary
Change Statistics
Model
R Square Change 1
DurbinWatson
F Change
df1
dfz
Sig. F. Change
7.571
1
12
.018
.387
(a) (b)
AdjustedR Square
.455
Predictors: (Constant), DCP Dependent Variable: GDP
ANOVA B, Sig.= .0180
APPENDIX6 Model Summary
b
Model
R
1
.8170
Model Summary
R Square .668
Adjusted R Square
Std. Error of the Estimate
.557
159 .7 556
b
DurbinWatson
Change Statistics Model
R Square Change .668
1
(a) (b) (c)
6.025
df1
dfz
1
3
Sig. F Change .091
1.783
Predictors: (constant), Tradergh Dependent Variable: GDP . Weighted Least Squares Regression-Weighted by STMKCAP •
Coefficients Sig.
F Change
=
b
.000 .006
60
c
