How NGX’s new exchange-traded derivatives could be a silver bullet for the stock market

Nigeria’s capital market performance crossed a significant Rubicon on Easter eve, April 14, 2022, with the launch of the NGX Exchange Traded Derivatives (ETD) market featuring equity index futures.

Though it’s taken so long, analysts believe it’s better late than never as the derivatives product launch aims to add depth and breadth to the Nigerian market, which many say is too shallow for the size of the economy is.

With the launch of the derivatives market, NGX listed two stock index futures contracts, the NGX 30 Index Futures and the NGX Pension Index Futures. NGX announced that it hopes to launch more derivatives products in the near future to diversify its offering, using this new asset class as an opportunity for portfolio managers to diversify their portfolios. Unlike exchange-traded funds, exchange-traded derivatives are imaginary portfolios whose price and performance depend on the underlying assets.

NGX explained that ETDs are standardized, highly regulated and transparent financial contracts that are listed and traded on a securities exchange and are guaranteed against default by the derivatives exchange’s clearing house.

NGX goes on to state that the ETDs market will complement existing asset classes, provide investors and other market participants with the necessary tools for tactical asset allocation, and improve risk and cost management for effective portfolio management. It will further increase the participation of domestic and international investors in Nigeria’s financial markets, which will positively deepen the market and support efforts to use the capital market as a lever for sustainable economic growth.

This development marked a step toward the exchange’s dream of expanded asset classes trading on its platform, with the aim of increasing liquidity and expanding investment opportunities for participants. With the introduction of derivative offerings, investors now have more risk management tools in their investment strategy toolkit. Traditionally, trading on the local exchange has been limited to three asset classes: stocks, fixed income (typically bonds, corporates and governments), and exchange-traded funds. Stocks are known to dominate market cap, in fact accounting for up to 70 percent of market cap value and over 95% of trading activity. The introduction of derivatives is intended to balance this imbalance.

Prior to its demutualization, the exchange listed a gold ETF, NewGold, which is an example of a commodity exchange-traded fund. The question that some retail investors keep asking is how a commodity ETF will help an investor, said Isaac Olorunlogbon, CEO of Deep Trust Capital Limited, who noted: “Investors holding ETFs can benefit from price increases on the underlying.” Assets in the fund benefit by tracking the stock market index, or in the underlying commodities held by the fund in the case of commodity EFTs such as NewGold. When gold prices rise, Newgold ETFs can benefit from their exposure to gold through their holdings in the ETF. Interestingly, in the case of Newgold, investors have also benefited from currency hedging over time as gold is valued in foreign currency.”

Although investors in commodity ETFs do not hold the commodities directly. By tracking the movement of such commodities through their holdings in funds that invest in the commodities, investors have an opportunity to take advantage of such positive price movements.

NGX Chief Executive Officer Mr. Temi Popoola commended the efforts of stakeholders who have successfully pushed the completion of the futures market after careful preparations over the past eight years. “I would particularly like to acknowledge the work done under the Exchange’s previous leadership under the leadership of Mr. Oscar Onyema, whose contributions formed the basis of our current gains and achievements, which have been manifested through the launch of the NGX ETDs market. NGX remains committed to building an exchange that can meet the increasingly sophisticated needs of domestic and foreign investors.

“A strong pillar of our strategy is to improve liquidity and expand market capitalization so that we create value for stakeholders, and the launch of ETDs is a crucial step in the right direction. The platform will play a key role in expanding and deepening the market and reinvigorating NGX’s leadership position as Africa’s exchange hub of choice.”

NGX added that to promote clearing efficiency, stability and trust, the exchange has worked with a leading Nigerian Central Counterparty (CCP), NG Clearing Limited, to upgrade the clearing infrastructure for NGX Derivatives Market and its clearing members – Access Bank and Zenith – provide bank. The ETDs market will begin trading activity from the first three trading license holders – Cardinalstone Securities Limited, Meristem Securities Limited and APT Securities and Funds Limited – cleared by NGX Regulation Limited to allow transactions on behalf of investors in the NGX futures market .

The connection to Onyema in the development of financial products on the Nigerian Stock Exchange is quite significant. On April 4, 2011, Onyema assumed the position of Chief Executive of the then Nigerian Stock Exchange after the bourse’s crisis at the time was resolved. On that day, Onyema opened trading on the exchange by ringing the bell.

“I didn’t see Nigeria as a place I wanted to come to, but when the opportunity presented itself, I thought it presented me with a unique opportunity to build a legacy of change, a legacy of transformation, a legacy that evolves positively impacting the lives of millions of Nigerian investors,” Onyema said in an interview with this reporter on November 27, 2013 on the 23rd floor of the Nigeria Stock Exchange building in Lagos.

When Onyema took over leadership of the Nigerian Stock Exchange (now known as Nigerian Exchange Limited) in 2011, the market was in dire need of leadership and direction and Onyema was ready to provide it. As he puts it, “There really is nothing new under the sun. You just have to replicate everything and make sure everything you do is very appropriate for the local market.”

A key area with a yawning need was product launch to deepen the market.

“We need to introduce derivatives – options and futures – so that we can benefit from the network effect,” Onyema said in the 2013 interview. “These will help investors manage the risks associated with investing in financial stocks. So if you know you are dealing with a company, say Nigerian Breweries, and you can option it to protect your downside, you would take larger positions in the company.”

The advantage accrues to a typical investor in this way: People’s expectations about how the market or a particular security will perform in the future will always differ, and as a result there are few people who will view a security’s performance in exactly the same way . This is the basis of option contracts that create space for mutual benefit for both parties. So, in Onyema’s example, the investor holding shares in Nigerian Breweries is willing to enter into an option contract with another investor who expects the share price to rise more than his own.

If you know that you can trade a futures contract on foreign exchange on the exchange, you are likely to feel more confident in conducting your business if your business involves importing or exporting products because you can hedge your currency risk.

So there are many network effects that the exchange can extract from the five products, and all of these will propel the march towards the $1 trillion market cap.

While experts say the market needs a lot of education to effectively monetize the derivatives offerings, especially as some say it carries a higher level of risk compared to the plain vanilla cash stocks. However, NGX leadership believes this could be the silver bullet that would take the market cap of just under $61 billion to Oscar Onyema’s target of $1 trillion.