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WRITTEN BY; GREATNESS EYONSA .E.

 

INTRODUCTION

Security lending transactions can be best described as the spinal cord of the Nigerian capital market as it plays a pivotal role in the capital market by providing liquidity, which in turn reduces the cost of trading and promotes price discovery.

Despite the importance of security lending transactions in Nigeria, several impediments have constantly stared at the face of security lending transactions in Nigeria which has eventually resulted to some shortcomings and pitfalls in Security lending transactions in Nigeria.

However, this paper seeks to x-ray an overview of securities lending transactions in Nigeria, its risks, as well as its prospects.

 

SECURITIES LENDING TRANSACTIONS IN NIGERIA

It is apt and pertinent to underscore the meaning and scope of security lending transactions in Nigeria before transcending into the realms of the overview of security lending transactions in Nigeria.

Security lending is the temporary transfer of securities, from one party to another, with a simultaneous formal agreement to return the securities either on demand or at an agreed date in future. According to the provisions of Section 315 of the Investments and Securities Act, security lending is defined as; ‘the temporary exchange of securities, generally for cash or other securities of at least an equivalent value, with an obligation to redeliver a like quantity of the same securities on a future date and includes securities loans, repurchase agreement(repos) and self-buy back agreements.’’

It has also been defined as the practice of loaning shares and stock, commodities, derivative contracts, or other securities to other investors or firms. Security lending requires the borrower to put collateral, whether cash, other securities, or a letter of credit.

Securities lending and borrowing transactions are governed by the terms of securities lending agreements aligned to terms and conditions as agreed by the parties and in line with international best practices. The lending agreement must be completed, and it sets forth the terms of the loan including duration, fees and the nature of collateral (cash, government securities, equities among others).

It is also important to mention that during the tenor of any securities lending transaction, the title and ownership of the security are also transferred to the borrower. The borrower is obliged to return the security either on demand or at the end of an agreed term.

Borrowers are typically market participants such as market makers, portfolio investors, broker-dealer firms, investment banks, intermediaries, stockbrokers and other similar organisations.

Lenders are usually institutional investors, pension funds, mutual funds, sovereign wealth funds, investment companies, some High Net-worth Individuals (HNI) as well as insurance companies that are long or medium-term investors in the securities market. We also have high net worth individual investors whose interest is to grow the value of their portfolios over the medium to long term. They, therefore, lend securities to earn a lending fee, cover costs, create performance enhancements, and increase the return on their portfolio.

It is important to note that there are litany and plethora of benefits of security lending transactions. One of them is that, it facilitates various trades that allows investors or institutions to hedge, take a bespoke position, or in arbitrage situations. Also, it allows for ability to earn additional income through the face charged to borrower to borrow the security as well as providing liquidity to markets which can generate additional interest income for long term holders of securities, and allows for short selling.

Security lending transactions in Nigeria is one that is beautifully adorned with a garment of benefits, however, it has been engulfed with myriads of impediments, shortcomings, pitfalls, and risks. However, the risks facing security lending transactions in Nigeria shall be discussed hereunder;

 

RISK OF SECURITY LENDING TRANSACTIONS IN NIGERIA

One of the major risk that has posed a threat to security lending transactions in Nigeria is that the borrower becomes insolvent and the value of the collateral provided falls below the cost of replacing the securities that have been lent.

There are three major risk in security transactions in Nigeria and there are; borrower default risk, operational risk, and cash collateral reinvestment risk. Borrower default risk is one that occurs where the counterparty fails to return the borrowed security back to the lender. Cash collateral reinvestment risk is a larger source of risk. It is one that if reinvested too aggressively and the risk taking results in losses, then the fund may suffer losses. Operational risk is one that arises from failed and inadequate procedures, systems or policies. In this case of securities lending this may include, but is not limited to, errors in transactions between the lending agents and the borrower, errors and faults in transaction flows, faults in the IT platforms, e.t.c.

 

 

THE WAY FORWARD

The Nigerian Stock Exchange’s securities lending market is valued at N1.07 billion ($2.96million) according to official data by the Exchange. The NSE, in its Securities Lending Report of October 2019, said 20.78 million shares were available for lending to investors, which is a 3,307 per cent increase from the 61,435 shares available for lending in the whole of 2019. The Nigerian securities and exchange commission and the Nigerian Stock Exchange have existing rules and regulations which unequivocally erects a legal framework poised at regulating securities lending transactions in Nigeria but operators in the Nigerian capital market are unwilling to rely on these rules to engage in securities lending transactions because of the tax issues. Therefore, lawyers have a key role to play by creating awareness on the changes in the Act and possible impact in securities lending.

Also, the security and exchange commission have another huge role to play. There is need to sensitize lawyers and understand the documentation for securities lending agreement in the Nigerian market and whether it is necessary to have a master securities lending agreement for the Nigerian market. It may also be necessary for the Federal Inland Revenue Service to issue guidelines on the implementation of the provisions of the Act in relation to securities lending.

 

CONCLUSION

We believe that the introduction of these and other policies is a step in the right direction, but time will tell the extent to which the implementation of these measures would impact domestic lending and the general economic outlook in Nigeria.

Additionally, there have also been legislative changes which are predicted to have positive impact on lending. For instance, on 7 August 2020, President Muhammadu Buhari assented to the Companies and Allied Matters Act 2020 (CAMA 2020). The CAMA 2020 repealed and replaced the 30-year old Companies and Allied Matters Act 1990, which was modelled after the English Companies Act 1985. CAMA 2020 is a major legislation aimed at improving the ease of doing business and could, therefore, significantly impact lending in Nigeria. As part of its changes, CAMA 2020 now limits the cost of registration of security with the Corporate Affairs Commission (CAC) (Nigerian’s company registry) to 0.35% of the value of the charge, which is a significant reduction from the previous 1% and 2% for private companies and public companies respectively.

Some of the other key innovations introduced by CAMA 2020 which we believe could have a positive impact on lending transactions in Nigeria include:

Introduction of netting provisions, which should now provide legal certainty to financial institutions entering into financial contracts such as derivatives and repurchase agreements.

Introduction of the definition of book debts and exclusion of marketable securities and negotiable instruments from the definition of book debts, which may settle the question of whether a fixed charge of instruments such as treasury bills is registrable.

Re-introduced the priority of fixed charges over contributions due and unpaid under the Employees Compensation Act 2010.

Introduction of company voluntary arrangements and administration, which are procedures that companies experiencing financial difficulties could embark on with creditors to address financial challenges outside of insolvency.

Another new legislation that has significantly impacted lending is the Finance Act 2019, a tax legislation, which came into effect on 13 January 2020 and which amended some provisions of key tax legislations in Nigeria. The Finance Act has adjusted the tax exemptions applicable in relation to interest payments on foreign loans. For instance, a loan with more than seven years tenor and a grace period of at least two years on the payment of both interest and principal initially entitled to a 100% tax exemption on interest payments is now subject to a maximum of 70% tax exemption. The implication of the amendment is to adjust the tax exemption applicable to interest payments on foreign loans to the next lower rate of exemption as provided in the Finance Act.

In addition, the recent amendment to the Stamp Duties Act by the Finance Act now defines instruments to include written documents and electronic documents and makes provisions for electronic documents to be liable to stamp duties. This has major implications for stamping of finance documents and would affect the structuring of transactions including the previous tax planning opportunity of executing and keeping documents offshore and only transmitting electronic copies to Nigeria so as to delay or eliminate the payment of stamp duty. This will also exacerbate the administrative decision of the Federal Inland Revenue Service (FIRS) in 2017 to increase the rate of stamp duty payable on unsecured loan agreements from a nominal rate of NGN500 to 0.125% of the loan amount, which continues to affect the market. This amendment in respect of the stamping of electronic documents and the increase by the FIRS have overall increased the cost of lending.

Finally, online lending business by Fintech companies and some Nigerian banks continue to grow and have also expanded the scope of funding for MSMEs as well as increased the level of lending transactions in Nigeria. Although most of the CBN initiatives mentioned above are mainly directed to deposit taking banks, the CBN has recently asked commercial banks to share their customers’ data with fintech companies in order to increase access to financial services and provide better services to customers. This suggests that the CBN may, in the long term, be looking to encourage open banking policy that would require banks to open their account base to fintechs to bring more people into the financial system.


 

‘Securities lending will move Nigeria from frontier market to emerging market’

Greatness Eyonsa .E.

Cap. I24, Laws of the Federation of Nigeria (LFN) 2004.

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https://ngxgroup.com/exchange/trade/equities/securities-lending-shortselling/

Nigeria Securities Lending set for Boost in Opportunity for Lawyers 

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