Global credit rating agency Fitch Ratings has raised concerns over Nigeria's proposed $5 billion Total Return Swap (TRS) financing arrangement, warning that while the deal could strengthen the country's liquidity position and broaden funding options, it may also expose Africa's largest economy to fresh debt-management and financial stability risks.
The warning comes amid reports that the Nigerian government has secured approval for a $5 billion financing facility from First Abu Dhabi Bank through a Total Return Swap structure backed by local-currency government bonds.
In a special report released on Monday, Fitch acknowledged that TRS financing has become increasingly attractive for emerging-market governments seeking alternative funding sources outside traditional Eurobond markets. However, the agency cautioned that the structure carries significant risks, particularly in countries facing currency volatility and fluctuating domestic interest rates.
According to Fitch, Total Return Swaps allow governments to obtain hard-currency financing by pledging sovereign bonds as collateral. Because these arrangements are typically treated as contingent liabilities rather than direct debt obligations, they often remain outside conventional public debt statistics.
While this can help governments access foreign exchange and diversify funding channels, Fitch warned that it could also make sovereign debt positions less transparent.
“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,” the agency stated.
The report added that such financing structures could “weaken legislative and market oversight and make the potential for margin calls harder to assess.”
Designed for Liquidity, Not Market Access
Fitch noted that Nigeria's proposed transaction appears to be aimed at improving liquidity management and broadening funding sources rather than addressing difficulties in accessing 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.
The arrangement is expected to provide the government with additional foreign-currency liquidity at a time when authorities are seeking innovative financing options amid tight global financial conditions and increasing fiscal pressures.
Currency and Interest Rate Risks
Despite the potential benefits, Fitch stressed that the structure could become problematic if economic conditions deteriorate.
The agency warned that a depreciation of the naira or a sharp rise in domestic borrowing costs could trigger margin calls that would need to be settled in US dollars, creating additional pressure on Nigeria's external reserves.
“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 said.
The report explained that one of the key vulnerabilities of Total Return Swaps is that the value of the pledged bonds may decline during periods of financial stress. Such declines could force governments to provide additional collateral or cash at precisely the moment when liquidity is already scarce.
“Falling bond prices during a period of stress can generate unplanned hard-currency demands when external liquidity is already constrained,” the agency noted.
Fitch emphasized that these risks would be taken into account in its future sovereign credit assessments.
Transparency Concerns Persist
Another major concern highlighted in the report relates to disclosure standards surrounding TRS transactions.
According to Fitch, critical details such as pricing mechanisms, fees, collateral valuation thresholds, margin requirements and termination clauses are often not publicly disclosed, making it difficult for lawmakers, investors and analysts to fully evaluate the financial implications of such deals.
The agency stressed that transparency is a crucial component of sound debt management.
“Reduced transparency limits the ability of legislators and markets to assess the true cost, scale and structure of sovereign borrowing, and can weaken confidence and complicate risk assessment,” Fitch stated.
The report argues that limited disclosure could undermine accountability and make it more difficult for stakeholders to understand the government's actual debt exposure.
Details of the Proposed Facility
Fitch disclosed that Nigeria's planned facility with First Abu Dhabi Bank is estimated to have a maturity date of 2032 and a total value of $5 billion.
The transaction would reportedly be secured by approximately $6.67 billion worth of naira-denominated government bonds and would include provisions for margin calls if the value of the collateral falls below agreed thresholds.
The agency compared Nigeria's planned deal with similar financing arrangements previously undertaken by Angola and Senegal, noting that several African countries have increasingly explored Total Return Swaps as alternative funding mechanisms.
Lessons from Angola
Fitch pointed to Angola's experience as a cautionary example of the risks embedded in such structures.
According to the report, Angola previously faced a significant margin call during a period of global market turbulence and was forced to draw on its foreign-exchange reserves to meet its obligations.
Although the situation was eventually stabilized, Fitch said the episode illustrated how TRS arrangements can intensify liquidity pressures during periods of economic stress.
The agency warned that countries with limited financial buffers may be particularly vulnerable if market conditions suddenly deteriorate.
Uncertainty in Debt Restructuring Scenarios
Fitch also highlighted a major unresolved issue surrounding Total Return Swaps: how they would be treated if a sovereign country were forced to restructure its debt.
The agency noted that no established precedent currently exists.
“There is no precedent for how TRSs would be treated in a sovereign restructuring. Their derivative form and limited disclosure create material uncertainty,” Fitch stated.
This uncertainty, according to the report, could complicate future negotiations between governments and creditors and potentially affect recovery prospects for conventional bondholders.
Growing Importance for Emerging Markets
As more emerging-market governments turn to innovative financing structures, Fitch believes close monitoring will become increasingly important.
“The extent to which TRS exposure weakens recovery prospects for conventional bondholders depends on its size relative to total debt. As TRS financing grows across emerging markets, monitoring this share becomes an increasingly important input in the recovery analysis of sovereigns with TRS exposure,” the agency said.
Nevertheless, Fitch acknowledged that Total Return Swaps can offer genuine advantages, including improved access to external liquidity, potentially lower borrowing costs and greater flexibility in managing government financing needs during periods of tight global credit conditions.
The warning from Fitch comes shortly after the International Monetary Fund reportedly urged Nigeria to exercise caution in pursuing the proposed $5 billion TRS arrangement with First Abu Dhabi Bank, describing such structures as relatively opaque and potentially risky despite the country's improved access to international capital markets.
As Nigeria continues to explore alternative financing avenues to support fiscal and economic objectives, analysts say the success of the proposed deal may ultimately depend on how effectively the government manages transparency, market risks and potential future obligations arising from the transaction.