Nigeria’s proposed $5bn total return swap financing arrangement could expose the country to additional debt-management and liquidity risks despite its potential benefits, global rating agency Fitch Ratings has warned.
Fitch said that while total return swaps can provide governments with hard-currency liquidity, diversify funding sources, and lower borrowing costs, the structure could create transparency concerns, increase exposure to market shocks, and weaken recovery prospects for conventional creditors if not carefully managed.
The report comes weeks after reports emerged that Nigeria had secured approval for a $5 billion financing arrangement with First Abu Dhabi Bank using a total return swap structure backed by local-currency government bonds.
Fitch noted that total return swaps have become increasingly popular among some emerging-market sovereigns seeking alternative sources of financing outside traditional Eurobond markets.
The rating agency explained that under such arrangements, governments pledge bonds as collateral in exchange for cash financing, with the pledged securities typically remaining outside standard debt statistics because they are treated as contingent liabilities rather than direct debt obligations.
According to Fitch, while the structure can help governments obtain foreign-currency funding, it may also obscure the true scale of sovereign liabilities.
The report stated, “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.”
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It added that such arrangements could “weaken legislative and market oversight and make the potential for margin calls harder to assess.”
Fitch said Nigeria’s planned transaction was primarily designed to support liquidity management and diversify funding sources rather than address an inability to access international capital markets.
“Nigeria has approved and reportedly executed a TRS. Fitch believes that the proposed structure, which would pledge naira-denominated bonds against hard-currency financing, is similarly motivated by funding diversification and liquidity management rather than market access constraints,” the agency said.
However, the agency warned that the arrangement could expose the country to additional pressure if domestic interest rates rise or the naira weakens.
It stated, “Margin calls payable in US dollars against naira-denominated collateral could generate hard-currency pressure either if domestic yields rise or the naira weakens.”
Fitch further explained that total return swaps carry structural risks because the value of pledged collateral can decline during periods of economic stress, potentially triggering additional funding demands at a time when liquidity is already constrained.
The agency noted that “falling bond prices during a period of stress can generate unplanned hard-currency demands when external liquidity is already constrained,” adding that such risks would be factored into its sovereign rating assessments.
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