Last week, the Nigerian news media was replete with reports that Municipality Waste Management Contractors Limited, a private company promoted by Visionscape Sanitation Solutions Limited, might have defaulted on the payment of the N4.5 billion coupon interest which was due on March 4th, 2019.

SEC Weighs in – In an attempt to exonerate itself, the Securities and Exchange Commission, SEC,  notified the public, via a public notice posted on its website, that the bond was not issued to the public; rather to a few private investors through a private placement. According to the notice, the fact that it was a private placement excludes the offer from the purview and regulatory oversight by the Commission.

Investors on their own – By issuing that notice, the SEC had simply told the investors involved that they are on their own. For while the insinuation by the SEC may be correct, it does not send a good signal to investors. Moreover, such a reaction could undermine the private placement aspect of bond or stock market transactions. Over the counter transactions, like private placements, have long been known to have more risks than those executed in organized markets. That is why in most markets, private placements are meant for accredited and high net worth investors with high-risk tolerance and appetite.

Bonds and risks – This default in the payment of coupon is one of the risks inherent in bond investments. This is credit risk — the risk that the bond issuer or a borrower will be unable to pay the interest and or principal as at when due. Credit default does not seem to be a common event in Nigeria as most of the bonds on issue or outstanding are issued by the Federal government, State governments or blue-chip corporate bodies. However, this default by Visionscape should be an eye-opener to bond investors that credit default is real and could happen. The possibility of defaults should, therefore, be priced into the offering by investors when entering into bond transactions, especially through private placements. More importantly, investors should seek out ways to hedge against the loss of their investment.

How to mitigate the risks

Credit Default Swaps – One way that bond investors have hedged against default is through credit default swaps. A credit default swap is a financial derivative used to transfer credit risk. For a bond investor to protect himself from default, he will buy a credit default swap and in return makes payments to the credit default seller at agreed intervals usually, quarterly. By so doing, the credit protection seller guarantees to pay the protection buyer, the notional of the reference obligation, usually a bond, in this case, the Visionscape Municipality Bond or the interest depending on the underlying agreement between them.

It’s like insurance – Simply put, a credit default swap is like an insurance policy on the bond, where the buyer of the insurance makes regular payments so that if the bond issuer defaults, the insurance company steps in and makes the required payment that the issuer could not.

Not available in Nigeria – It does not look like credit default swaps are currently available in Nigeria, but this is an opportunity for Banks and Insurance company to broaden their revenue base by coming up with credit default swaps. By so doing, they will not only diversify and increase their revenue, they will also increase liquidity and activity in the bond market.

Business for FMDQ – This may be yet another opportunity for Nigeria’s FMDQ to also increase its oversight of the over the counter market in Nigeria and also start protecting Nigerian bond investors by offering credit default swaps.

Like every insurance policy and transaction, the selling and buying of credit protection through credit default swaps may have some moral hazard effects. Moral hazard, in this case, is the risk that a bond issuer will default intentionally because the issuer knows that investors have taken out credit “insurance” on the bond. Investors should not worry about this because, most of the time, the issuer does not know and does not have to know if anyone has bought protection on their bonds.

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