Fitch cautions Nigeria over risks in $5bn swap deal

Global rating agency Fitch Ratings has issued a caution to Nigeria regarding the potential debt-management and liquidity risks inherent in its proposed $5 billion total return swap (TRS) financing arrangement.

Fitch's special report highlights that while TRS can provide emerging markets with crucial hard-currency liquidity, diversify funding sources, and potentially lower borrowing costs, the structure itself presents significant challenges if not managed meticulously. The agency warned of transparency concerns, increased exposure to market volatility, and weakened recovery prospects for conventional creditors.

This warning comes weeks after reports indicated Nigeria had secured approval for the $5 billion financing deal with First Abu Dhabi Bank. The arrangement is reportedly backed by local-currency government bonds. Fitch noted the growing popularity of TRS among emerging market sovereigns seeking alternatives to traditional financing methods like Eurobonds. In these deals, governments pledge bonds as collateral in exchange for cash, with the pledged securities often excluded from standard debt statistics, being classified as contingent liabilities rather than direct debt.

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TRS may be structured under contractual agreements whose terms and conditions are only partly disclosed, reducing transparency of the true scale and terms of sovereign borrowing.

Fitch explained that this structure, while facilitating foreign-currency funding, can obscure the actual extent of a nation's liabilities. The terms of TRS agreements may not be fully disclosed, reducing transparency regarding the true scale and conditions of sovereign borrowing. This lack of transparency can weaken legislative and market oversight, making it harder to assess the potential for margin calls. The agency believes Nigeria's transaction is primarily aimed at liquidity management and funding diversification, rather than reflecting an inability to access international capital markets.

However, Fitch cautioned that the arrangement could exert additional pressure on Nigeria if domestic interest rates increase or the naira depreciates. Margin calls, payable in U.S. dollars against naira-denominated collateral, could create hard-currency strain under such conditions. The rating agency also pointed out the structural risks associated with TRS, where declining collateral values during economic stress could trigger unplanned hard-currency demands precisely when liquidity is already scarce.

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Margin calls payable in US dollars against naira-denominated collateral could generate hard-currency pressure either if domestic yields rise or the naira weakens.