Capital market liquidity and transparency gets some more shine


Sunday, February 1, 2015 11:52 AM / ARM Research

Today we conclude the review of the domestic environment in our core strategy document – Nigeria Strategy Report, with a review of capital market initiatives as well as implications the deteriorating macro fundamentals could have on sovereign rating.

NSE on course to bolster capital market awareness
As follow-up of its West African Capital Markets Integration Council (WACMIC) propositions, NSE is poised to push through the initial phase of the sub-programme–support of Direct Market Access (DMA) ahead of the eventual Sponsored Access--in pursuit of greater foreign investment. This will allow domestic brokers in constituent countries of the WACMIC to trade securities as well as settle in markets other than theirs through counterparties in those markets. However, the domestic broker–dubbed the Sponsoring Member (SM)–would be mandated to inform the NSE of the DMA arrangement with the Sponsored Participant (SP) in the remote country, for whom the SM must also have full responsibility. This responsibility includes the acceptance of whatever risks is associated with possible infractions that may arise as a result of the SP’s participation in trading activities as well as keeping its infrastructure open as pass-through for DMA transactions. To the former point, the NSE’s recent expulsion of two brokers on grounds of infringements in H2 14 serves as a reminder of both NSE’s renewed drive to stamp out infractions as well as the magnitude of responsibility expected of SMs.

On other fronts, the FGN recently approved VAT exemption on commissions[1] applicable to capital market transactions in a bid to boost activity in the Nigerian equity market. In particular, the severing of VAT on stock market transaction fees raises expectations for a reduction in overall transaction cost for investors. According to FGN gazette this exemption is effective for a period of 5 years. An added boost to market rejuvenating efforts is NSE’s admission as full member of World Federation of Exchanges (WFE), from previous observer status. Aside being a recognition of the NSE’s efforts over the past few years, we believe this inclusion could fast-track the regulator’s bid for full integration with global markets and exchanges whilst removing any exchange-status based limitations for investors with such restrictions.

Still on the theme of increased interaction with markets and investors, though tilting more to domestic efforts, NSE, in association with Convention on Business Integrity (CBI), launched Nigeria’s first ever Corporate Governance Ratings System (CGRS) in November, 2014. Specifically, this could tie into the objectives of WACMIC, by potentially bolstering overall trust and market perception of the Nigerian equity market, including means to measure same, with expected knock-on effects from anticipated new businesses from risk-oriented and/or ethically sensitive business partners and investors.  

FMDQ: humble beginning, lofty aspiration

A fall-out from the global financial crisis has been a shift towards greater regulatory scrutiny of financial markets, in particular OTC dealings. In Nigeria, this took shape with SEC’s licensing of FMDQ OTC–a self-regulatory institution established in November 2013 to provide organization and oversight over OTC transactions in money, FX and fixed income. Amongst other things, the exchange was also expected to guarantee proper market governance, as well as standardize market operations, practices and businesses across the main OTC products. To achieve the latter, the exchange was earmarked to provide a single operating platform, wherein pre-trade and post-trade data would be aggregated in a bid to enhance market transparency.

Starting off, FMDQ tackled the issue of transparency in the OTC market with the launch of the Daily Quotations List (DQL) in November 2013. The DQL provides market-traded rates in the money and FX markets as well as market-traded yields for all fixed income securities as against the previous era where different sources of market yields were obtainable. Given the trade based nature of DQL data, the FMDQ now provides a veritable source of information on the size and liquidity across the various OTC markets, thereby aiding price discovery.

Other developments on transparency include the April 2014 review of the old NIBOR curve–a most criticized OTC fixing–to ensures its compliance with the 19 principles of the International Organisation of Securities Commission (IOSCO). The review resulted in a collapse of the number of tenors for NIBOR from seven to four (overnight, one, three, and six months) in compliance with IOSCO benchmarks. Further developments in May 2014, saw the exchange license its first batch of dealing members in the form of banks and discount houses.


The FMDQ followed that up with the establishment of the Bloomberg E-Bond system in March 2014. The Bloomberg E-Bond is a robust trading architecture for the trading of Nigerian government bonds with enhanced features for price discovery and integrated trading—execution, capturing and reporting. The quasi-exchange features solves information asymmetry problems associated with the old OTC systems and permits easy access for market oversight entities and regulators to review market activity and audit transactions. Complementing the trading platform, FMDQ developed the FMDQ Bond Specialist System (BSS) in a bid to boost the profile of non-sovereign debt. The BSS ensures that FMDQ dealing members make firm bids as well as offer best-effort quotes to willing participants to ensure competitive pricing for non-FGN instruments. Coinciding with the establishment of S4 depository system for bonds by the CBN, the foregoing bolsters the profile of the local bond market.

As at November 2014, FMDQ OTC also witnessed the licensing of 36 new members across its associate and registration member categories. Completing the round of achievements, FMDQ secured SEC approval in December 2014 to list bonds on its platform providing an alternative option to the NSE. The alternative platform provides greater competition for domestic bond listing and trading which augurs well for issuers and investors alike while equally driving an improvement in service delivery by both exchanges.

CBN nods to spark CP market rebirth… 

FMDQ OTC’s not-so-hidden initial focus was the Nigerian interbank market – money, repo, foreign exchange, treasury bills and bonds. However, following 4 years of falling commercial paper (CP) activity in Nigeria,[2] the revival of the CP market was again stepped up as CBN’s no objection stance on the proposition to revamp CP dealings in August 2014 paved way for the take-off of fresh CP quotations, this time, on the FMDQ OTC platform[3]. This was on the back of FMDQ’s expressed readiness with the draft rules for the market that could see Deposit Money Banks (DMB) free short term credits from their books. This CP rejuvenation, we believe, would bode well for banks as they focus on ramping up long term funds in a bid to commence Basel III. Going forward, we also expect this development to provide companies with alternative source of short term credit as well as increase scope for investments in alternative assets for corporates, fund managers, or PFAs seeking greater diversification or more efficient ways to raise funds. To this point, we note that PENCOM regulations place a restriction on the amount of deposits PFAs can place with commercial banks while giving allowance for allocations to CPs.

On other fronts, and more importantly, open publication of redeemed and unredeemed CPs on the FMDQ platform is more likely to bring about improved transparency. It is expected that this would blot out the negative sentiments that greeted several abuses in the use of the product prior to CBN’s intervention in 2009[4]

…But its adjustment of NOP could boomerang on liquidity quest  

To rid currency market of speculative activity, the CBN issued a circular which instructed banks to hold zero trading positions over-night, relative to 1% of shareholder funds previously.  This action which immediately curbed liquidity in the interbank forex market, as traders were reportedly reluctant to quote prices for fear of not being able to unwind same before close of day portends a significant setback to FMDQ OTC’s increased liquidity drive at the forex markets. Clearly, CBN appears to be rolling back prior liberal policies in response to mounting pressures of crude oil prices and the derailing naira. Given the sizable share of FX trades on the OTC platform the development crimps liquidity and could distort price discovery on the platform. Furthermore, the tightening FX market triggers downward adjustment in activity in debt markets, in particular for execution of FPI trades given the minimum secondary trading standards for bonds and NTBs. Whilst the apex bank moves are meant to shore up currency, the resulting illiquidity to OTC debt market could result in adverse perception of Nigeria’s bond market. 


In sum, FMDQ OTC initiatives aid the improvement of the Nigerian financial market landscape, in particular debt markets, where greater transparency and liquidity should permit the development of more sophisticated intermediation instruments, in the process deepening domestic capital markets.

No change in ratings, for now
Despite turmoil across domestic financial markets in response to oil price plunge, Nigeria’s sovereign ratings by Moody’s and Fitch were left unchanged from H1 14 update at Ba3 and BB- respectively in most recent updates. In its December update, Moody’s cited offsetting impact of Nigeria’s lower debt metrics to risks of weaker fiscal balances and slack pace of structural reform as the basis for its unchanged ratings stance. In addition, whilst noting lower budgeted capital spending, the agency pointed out that Nigeria’s infrastructural spending would remain higher driven by increased multinational investing and cited the instance of China’s $12 billion railway investment. Similar sentiments were shared by Fitch’s December release which despite lowering its projected 2015 growth for Nigeria left its rating unaffected from H1 14. 

The linkage to debt is in line with recent rating actions among oil exporters where on account of the existence of large maturing foreign obligations and sizable external financing requirements, Russia and Venezuela were downgraded with the latter also witnessing significant political upheaval. On this wise, the adverse effect of oil prices on Nigeria’s macro-picture raises the potential for negative ratings actions. This view is further supported by the fact that amongst the EM oil exporters that have dollar Eurobonds, Nigeria is only next to the two that have already been downgraded in terms of deterioration in Eurobond yields over H2 14, evidence of sovereign risk perception as oil prices fell. Whilst Nigeria has a significantly lower external debt profile which should shield her from a ratings downgrade (and probably already contributes to current stability), tail risks of political unrest around 2015 elections could yet drive scope for negative ratings action in 2015 with a possibility of a downward outlook revision at the minimum.



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