What are Forex Derivatives / Currency Swaps?
Currency products include foreign exchange hedging products (or FOREX hedges) which are used by SMEs to eliminate or “hedge” their foreign exchange risk when trading in foreign currencies. Similar to interest rate hedging products, foreign exchange derivatives are complex financial products which may not be suitable for all companies and therefore require a thorough understanding of a business’s needs and ought to be explained to the highest standard. For non-sophisticated investors FX products pose significant risks with regard to losses where there may be a lack of clarity around the features, benefits and risks of such products.
The two most common types of Forex Hedging Products are:
- Forward Contracts
A Forward Contract secures a foreign exchange rate today for a foreign exchange transaction that will take place at a later date.
For example, a UK exporter enters into a contract today to sell stone to a US importer. The terms of the contract require the US importer to pay US dollars in a year’s time. The UK exporter now has a known US dollar receivable. Over the next year, the pound sterling value of the US dollar receivable will rise or fall depending on fluctuations in the exchange rate. To mitigate the UK Company’s uncertainty about the direction of the exchange rate, the UK exporter may choose to secure a rate at which she will sell the US dollars and buy pound sterling in 12 months. To accomplish this, she hedges the US dollar receivable by purchasing a forward contract.
An Option sets an exchange rate at which the Company may choose to exchange at, unless the current exchange rate is more beneficial, then the Company will not exercise the option.
For example, using the scenario above, prior to entering into the contract, the UK exporter has an anticipated shipment of stone, though it is not yet certain – bearing in mind that the stone is sold in US dollars. The UK exporter could purchase a pound sterling call option (to buy) and a US dollar put option (to sell) in the anticipated value of the shipment for which the UK exporter would pay a premium for. The maturity date could correspond with the 12 month period the UK exporter expects to be paid or the strike price could be at the current market level or at a sterling/dollar rate where the shipment would become unprofitable for the UK exporter.
There is a cost to the company for setting up a hedge, including not being able to profit in the event the foreign currency moves in the Company’s favour.
Foreign Exchange rates can be extremely volatile and Banks can capitalise on this risk to sell non-sophisticated companies complex products intended to protect their margins which can in fact lock them into purchasing more currency than needed at a rate which costs the company more than had they not hedged forex risk to begin with.
If you believe you were sold a complex forex hedge that ultimately resulted in your business incurring significant losses, you may have been mis-sold your currency hedge.
We are able to provide advice on a range of currency linked products, including currency hedges, swaps, caps, collars and multi-currency mortgages.
How can a currency hedge be mis-sold?
It is generally reasonable for an SME with exposure to FX rates to consider hedging potential risk, however, the key is determining the SME’s actual exposure to FX risk and the degree to which the provider adequately explained the mechanics and risks of the various product options.
We will assess each SMEs company structure and trading patterns/ and requirements to understand the company’s foreign currency receivables and/or payables. At Cooper Stern, we make it our priority to understand your business.
A Currency Swap or other Forex Hedge can be mis-sold where the provider has not adequately explained worst case scenario costs and how the products functioned, for example, if gains were capped and losses were unlimited.
There are specific regulatory requirements that the provider must fulfil in selling currency linked derivatives. We assess the entire sales process against this regulatory framework to expose breaches and identify heads of claim.
If you believe you were not provided sufficient information prior to entering into your fx product, call us today and we will provide a no-obligation review.