Forex swap trades
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If you already have an account please use the link below to sign in. If you have any problems with your access or would like to request an individual access account please contact our customer service team. A touch of the surreal has descended upon the market for foreign exchange swaps in recent weeks, as participants ponder whether the instrument ever truly existed. This existential angst stems from the incoming derivatives margin rules. In Europe, most counterparties will have to pay variation margin on forex swap positions from March 1. Many buy-side users, however, book the instrument as a forward and these are being margined from the start of A lack of guidance from regulators has led to confusion as market participants try to figure out for the first time whether the product is forex fact a swap or a forward, which will determine when it must be margined. Many dealers and advisers are said to be giving conflicting advice. Under the US margin regime, forex swaps are exempt from variation margining, but some fear cash-settled and so-called window forwards, where a settlement date is not specified, may nevertheless be caught from March 1, which would impact market participants such as mutual funds. For users of forex swaps, the treatment is crucial as many want to avoid the extra costs that come with margining their trades. The confusion has also muddied the waters for banks rushing to get buy-side counterparties to sign new regulatory-compliant derivatives collateral agreements, known as credit support annexes CSAsbefore March 1. Not all firms can easily move to another dealer, however, which could discourage them from using the instruments at all. Forex swaps allow a party to borrow in one currency and simultaneously lend in another at the spot rate, with the repayment being fixed at the forward rate as of the start of the contract see figure 1. Banks and corporates can use them for forex risk-free borrowing or lending, collateralised by the reciprocal repayment obligations, while others, such as asset managers, use them as a hedge in particular, trades roll forward positions they already have on. First, the asset manager would buy euros at forex. It would then execute a forex swap where it sells euros at spot and buys euros forward. The price of this trade is simply the difference between the spot and forward prices. The advantage of executing in this way is that an asset manager can negotiate the two components of the trade the spot price and the forward price separately. If it asked for one blended price that combines spot and forward, there would be a lack of flexibility to trade with whichever dealer has the best price for each component. This leaves the asset manager with three trades: If the two spot trades are done with the same counterparty they net to zero, so there is no need to book them, leaving behind the forward trade. Technically, this would result in the transaction registering as just one forward, and most asset managers would book it accordingly. But dealers have tended to book the forex swaps as an instrument in their own right. James Binny, head of currency for Europe, the Middle East and Africa at State Street Global Advisors SSGA in London, says market participants can make equally strong arguments that the instrument is a swap or a forward. The distinction is important. From March 1, non-financial counterparties in Europe, Canada, Japan and the US will be required to post variation margin on new non-cleared over-the-counter derivatives instruments. The rules on most OTC products align across jurisdictions, but some fall between the cracks. Forex swaps and forwards, for example, are required to be margined in Europe but not in the US. With the directive being applied from January 3,this is the date from which forwards need to be margined. On the face of it, this put the matter to rest until next year. But things have been made all the more complicated by the fact that variation margin implementation for forex swaps is still set to go ahead from March 1, despite the fact that the product can be defined as either a swap or a forward. If you look at it [in terms of] what it was you were actually trading, it was a forex swap. But lawyers say dealers and their clients have been forced to reach their own conclusions on the subject, and these can differ. Not everyone takes this view. Some asset managers feel that since the start of this year there has been a change in guidance from banks. Speaking to a lot of the banks, no one was coming off the fence. Forex forex swaps are exempt from variation margining, some market participants fear the Commodity Futures Trading Commission CFTC could treat forwards as non-deliverable forwards NDFswhich are caught by the incoming regime. The only forwards that would be exempt are [those] where you have no intention of continuing the trade and you intend to take delivery of swap currency. Other problems have emerged for more specific products. Registered US funds under the Investment Company Act have, for the past several years, settled deliverable forex as cash-settled instruments. This is thanks to an interpretation given by the Securities and Exchange Commission regarding leverage rules under the act. Investment firms that trade cash-settled contracts only have to segregate their liquid assets against the mark-to-market forex rather than the full notional swap, as would be the case if they traded physically settled derivatives. This quirk has made cash-settled forwards a popular instrument for US mutual funds. In addition, window forwards are being interpreted by one lawyer as variation margin-applicable contracts, absent any clarification from the CFTC. The confusion among market participants could not come at a worse time for the industry. Only a month remains until the March 1 deadline, and asset managers have completed only a tenth of the paperwork required to begin collateralising swaps, according to a recent survey conducted by the asset management arm of the Securities Industry and Financial Markets Association and the Investment Adviser Association, which represents advisory firms. Among the numerous difficulties facing their members that they outlined in a letter to global regulators, arguably the biggest is establishing CSAs between counterparties that have never previously had to sign them, which is particularly pertinent for clients that trade forex. Those that do exchange margin today are typically prime brokerage clients such as hedge funds, but there are exceptions. So we do it just as prudent risk management. Despite the last-minute help, other industry groups appear less than enthused about rushing through documents before the deadline and have called on regulators for a six-month reprieve, like the one offered in Australia, Hong Kong and Singapore. In a more extreme scenario, this could lead to some clients not hedging, particularly those smaller pension funds caught by the more prescriptive EU rules. This would introduce event risk. Events Awards White papers Research Books Jobs Newsletters Welcome My account Sign in. Risk Model Validation, London Q2 Risk is delighted to offer this specialist training course which has been designed to focus on the assessment of risk models in the context of concrete risk model implementation. Buy-Side Risk USA Risk. Structured Products Awards Asia Structured Products Awards Asia 05 Sep Date TBC - Hong Kong, Hong Kong. Asia Risk Awards This is the 17th year of Asia Risk Awards, which recognise best practice in risk management and derivatives use swap banks and financial institutions around the region. Structured Products Awards Europe Trades Products runs three global awards programmes - for the Americas, Asia, and Europe - to celebrate excellence across the structured products markets. Digital Channel Threat Report - Derisking Convenience This white paper examines the interplay between the challenges and opportunities afforded by the growing breadth of digital channels offered by financial institutions. Risk Management Systems for the Insurance Industry - Market Update This report updates the Chartis report Solvency II Technology Solutionsfocussing on swap management systems for the insurance industry. Capital Planning and Stress Testing under CCAR Lourenco Miranda Buy now. Chris Kenyon and Dr Andrew Green Buy now. Find the latest jobs. Search by job title, salary or location to find your perfect role. Don't miss out on new jobs Sign up. Job of the week. Forex swap margin treatment uncertain ahead of VM deadline With one month to go, market participants are still unsure how to treat foreign exchange derivatives. Robert Mackenzie Smith 06 Feb Tweet. Foreign exchange industry participants are at odds over which products will require variation margining from March 1. In Europe, forex swaps will be margined from March 1 and forwards from the start of Banks and the buy side can have different views about whether a forex swap is in fact a forward, creating confusion about when margining should begin. Market participants fear this could cause buy-side firms to flock to US banks as a result, splitting liquidity pools. However, many believe US regulators will require cash-settled forwards to be margined from March 1. Anatomy of a trade Forex swaps allow a trades to borrow in one currency and simultaneously lend in another at the spot rate, with the repayment being fixed at the forward rate as of the start of the contract see figure 1. Jurisdictional differences The distinction is important. EU banks will lose business to US dealers. Surprise RMB strengthening prompts unwinds 02 Jun Documentation concerns slow CNY forex derivatives growth 11 Apr Legacy booking models impede NDF clearing, banks say 20 Mar Margin rules lead to NDF clearing surge 30 Sep Currency spoofing probe could spell trouble for forex options 07 Jan China approves Isda framework for central bank forex trades 26 Nov Trump reforms, euro clearing and FRTB The week on Risk. Most read on Risk. You must be signed in to use this feature Sign in. Contact us Advertising About Incisive Media Terms and conditions Privacy and cookie policy RSS.
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