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A Foreign Exchange Swap is an effective and efficient cash management tool for companies that have assets and liabilities denominated in different currencies.
They allow you to utilise the funds you have in one currency to fund obligations denominated in a different currency while managing exposure to adverse currency movements.
You may use a FX Swap if you need to exchange one currency for another currency on one day and then re-exchange those currencies at a later date. A FX Swap may be used as an alternative to depositing or borrowing in foreign currency.
A FX Swap has two legs or stages (a near leg date and a far leg date).
On the near leg date, you swap one currency for another at an agreed spot foreign exchange rate and agree to swap the same currencies back again on a future date (far leg date) at a forward foreign exchange rate.
Simply put, a FX Swap is a contract in which two foreign exchange contracts - a Spot FX Transaction and a FEC (forward exchange contract) - are packaged together to offset each other (albeit with different settlement dates and exchange rates).
The exchange rates offered by a dealer in a FX Swap are determined by:
• The amount of the currencies being swapped;
• The exchange rates on offer in the foreign exchange market place for the currencies involved;
• The future date (far leg date) which you agree to swap the currencies back again (up to 24 months in the future); and
• The forward foreign exchange rate. This is calculated by adjusting the spot foreign exchange rate used in the near leg date of the FX Swap by a forward point adjustment. The forward point adjustment represents the interest rate differential between the countries of the currencies involved and compensates the seller of the currency of the far leg date with the higher interest rate, for the interest differential of the currencies involved that the seller could have earned (in the wholesale financial markets) if the swap transaction had not occurred.
The key benefits or main uses of a FX Swap
A FX Swap allows you to offset foreign exchange commitments where you will be receiving a currency on one date but need to make a payment in that currency at a later date.
A FX Swap guards against unexpected movements in exchange rates, and provides a degree of certainty in accounting and budget forecasts. It will reduce FX risk however interest rate risk is not eliminated.
FX Swaps can be undertaken in all the major currencies (GBP, USD, AUD, NZD, EUR, JPY, CAD, CHF) as well as a number of minor currencies.
The term of a FX Swap and how the term is set
The term and amounts for FX Swaps can be tailored to suit your particular needs and are agreed at the time you enter into a FX Swap.
The amounts payable and the method of calculating the amounts payable for a FX Swap
As stated above, a FX Swap has two legs (near leg and far leg dates) and always involves one currency being exchanged for another i.e. swapped.
• On the near leg date, you swap an amount of one currency for an amount of another at an agreed foreign exchange rate (Spot Rate) which will be determined by the foreign exchange rate on offer at the time of undertaking the contract.
• At the far leg date you agree to swap the currencies back again at an agreed forward foreign exchange rate again determined at the time of undertaking the contract.
The difference between the Spot Rate and the forward foreign exchange rate reflects the interest rate differentials between the countries of the two currencies, represented by forward points.
The foreign exchange rates offered in respect of both the near leg and far leg dates are determined by:
• the amount of the Sold Currency and Bought Currency;
• the exchange rates on offer in the foreign exchange market place for the currencies involved; and
• the date you wish to deliver your Sold Currency and receive your Bought Currency (up to 24 months in the future).
Payment of Initial Margin
After you enter into a FX Swap, the dealer will require you to immediately pay an amount (normally an amount between 0% - 20% of the total amount of the currency you are selling on the near leg date) called an Initial Margin, as advised at the time you entered into a FX Swap, and may require subsequent Margin payments if the exchange rates of the far leg date of your FX Swap move adversely.
Initial Margin is a part payment of the Sold Currency (being the currency you agree to pay for the currency you are buying) and acts as security for your FX Swap.
When you pay Initial Margin, it will be recorded the payment in your Account and, and should be held on trust for you in a separate “Derivatives Investor Money Account” until you settle your FX Swap.
You must be in a position to pay the Initial Margin immediately after the FX Swap is agreed.
If the Initial Margin required is not received within 2 Business Days your contract may be terminated and Closed Out with you being responsible for (and bearing) any loss arising from the contract being Closed Out.
Interest is not usually paid on Margin payments.
An FX Swap example:
A New Zealand company has NZD$1.5 million in a company bank account in New Zealand and has a requirement to fund AUD$1 million for its operations in Australia over the next three month period.
Rather than borrow AUD from its bank at a retail lending rate of say 10% (which would cost AUD $25,205.48 (based on borrowing for 92 days at 10%)) it decides to use its New Zealand dollars to fund this requirement using a FX Swap at a cost of NZD$5,431.10 (being the loss of interest receivable of NZD$9,537.21 less the Swap benefit received of NZD$4,106.11 as described below).
The company enters into a FX Swap selling its New Zealand dollars (NZD) and receiving Australian dollars (AUD) and vice versa in 3 months time.
Transaction date 12 May 2015 for spot value date 14 May 2015
NZD/ AUD exchange rates at 12 May 2015
Spot exchange rate ............ 0.9250
Forward exchange rate* .... 0.9215
*three months (14 August 2015) 92 daysForward points = Spot rate - Forward rate
Spot rate ............................... 0.9250
Forward rate ......................... 0.9215
Forward points benefit ........ 0.0035Interest Rates (365 day basis) as at 14 May 2015
AUD 2%
NZD 3.5%The forward rate is calculated as follows:
In cases where your surplus funds are in a currency with higher interest rates (e.g. New Zealand) and your funding need is in a country with a lower interest rate environment (Australia), the forward points will be “a benefit to you” for lending the higher interest bearing currency and vice versa.AUD Invested
AUD$1m x 2% x 92 days = AUD$5,041.10NZD Invested
NZD$1,081,081.08 x 0.9250 = AUD$1m
NZD$1,081,081.08 x 3.5% x 92 days = NZD$9,537.21Forward rate
(AUD$1,000,000.00 + AUD $5,041.10) / (NZD$1,081,081.08+NZD $9,537.21) = 0.9215In this example the company would receive a FX Swap Confirmation note as follows:
Deal type Swap near leg date Transaction Date 12 May 2015 Contract Number C123456 Value date 14 May 2015* You have sold NZD$1,081,081.08 You have bought AUD$1,000,000.00 Spot Rate 0.9250 Initial Margin payable NZD$ 54,054.05 *(being 2 days after the date you undertook the transaction) Deal Type Swap far leg date Contract Number C123457 Value date 14 August 2015* You have sold AUD$1,000,000.00 You have bought NZD$1,085,187.19 Forward Rate 0.9215 *(being 92 days after 14 May 2015)
An Initial Margin payment of say 5% of the Sold Currency (NZD$1,081,081.08 x 5% = NZD$54,054.05) will be required which acts as a security for the forward element of the swap contract.
The company would need to pay the dealer NZD$1,081,081.08 plus a margin of NZD$54,054.05 on or before 14 May 2015 and would in return receive AUD$1m.
Three months later the company would pay the dealer AUD$1,000,000.00 and would receive back NZD$1,085,187.19 plus the Initial Margin of NZD$54,054.05.
The above example provides an example of one situation only and does not reflect the specific circumstances or the obligations that may arise under a derivative entered into by you.
Margin Call Obligations
A FX Swap is subject to ongoing Margin obligations (Margin Calls) imposed by the dealer which act as security for your FX Swap (specifically for the swap far leg date of your FX Swap).
You are liable to meet all Margin Calls up to the total amount of the Sold Currency.
Margin Call payments are credited to your Account and are part payment of the Sold Currency.
Your Account balance must be more than the minimum amount of Margin cover required for your FX Swap(s). If not, a Margin Call may be made at any time (normally Margin Calls are determined daily) and you are obliged to meet Margin Calls by paying the required amount by the time stipulated in the Margin Call, normally within 2 business days (but may be payable immediately). If the Margin Call required is not received within 2 Business Days some or all of your FX Swaps may be terminated and Closed Out with you being responsible for (and bearing) any loss arising from the contract being Closed Out. You may or may not get a grace period
It is your responsibility to pay Margin and meet Margin Calls, up to the full amount of the Sold Currency (on the far leg date), on time and in cleared funds, so please keep in mind the possibility of delays in the banking and payments systems.
The timing and amount of each Margin Call will depend on movements in currency prices and the factors that impact negatively on the market price of the currencies involved in your FX Swaps.
There are no limits as to how often Margin Calls may be made but typically Margin Calls are unlikely to be made more than daily.
Margin Call example
In the example above, where the company has swapped NZD for AUD for a 3 month period. The company has paid the dealer NZD$54,054.05 as Initial Margin.
For the purposes of this example let's assume the NZD/AUD forward exchange rate subsequently depreciates to 0.8750.
In this situation the far leg date of the FX Swap is said to be Out-Of-The-Money by NZD$57,669.94
FEC cover
NZD$1,085,187.19Current forward rate
AUD $1m / 0.875 = NZD$1,142,857.14Out-Of-The-Money NZD$ 57,669.95
The company has only paid NZD$54,054.05 Initial Margin. The dealer will therefore make a Margin Call for a further NZD$3,615.90 (more likely to be rounded up to NZD$4,000.00) to ensure it has sufficient moneys from the company to secure the far leg of the FX Swap.
The total Margin (once paid) held in respect of the FX Swap is NZD$58,054.05 ($54,054.05 + $4,000.00) and will be repaid to the company on settlement day – 14 August 2015.
The above example provides an example of one situation only and does not reflect the specific circumstances or the obligations that may arise under a derivative entered into by you.
Settling FX Swaps
On the day of you entering into a FX Swap, the dealer will send you a Confirmation note which will set out the details of your FX Swap and will advise you of the amount(s), currencies and the date(s) upon which you will need to send money for each of the two legs of the FX Swap.
When each leg of your FX Swap reaches the Value Date (i.e. the settlement date for your FX Swap), and the dealer has received the balance of your Sold Currency in cleared funds, the dealer then instructs its bank to send the Bought Currency via international payment systems to your nominated account.
Any outstanding balance of the Sold Currency to be paid (once Initial Margin and any later payment of Margin, if any, has been taken into account) must be paid to the dealer no later than the banking cut-off time on the Business Day before the Value Date of the particular FX Swap.
All transactions are effected electronically and the dealer retains detailed records of all settlement transactions.
Method of Payment
Payments by you to the dealer must be by way of electronic transfer only. Cash and/or cheques are not acceptable.
For more information about Currency Swaps, please contact xe.
