OTC FX Derivatives - key risks and features

MiFID II

FX Option (buy) & Participating Forward, Zero Cost Collar, Forward Extra, Forward Extra Plus, Bonus Forward, Bonus Forward Extra, Release Forward & Range Forward

The OTC FX derivatives above are risk management tools that can be utilised in order to hedge FX risks and exposures generated through commercial activity. These products allow users to protect future cash-flows and remove the risks presented by market fluctuations for known future revenues or expenditures with additional features that offer some optionality and participation in
market moves. 

Key risks and features

  • Market Risk

    • Market risk can materialise due to macroeconomic factors and may have an impact on a particular instrument or more broadly on currency markets as a whole.
    • Market Risk is direct as the outcome on expiry is dependant upon the underlying market throughout the life of the product.
    • Whilst Market Risk exists each of these products provides a known worst-case protected rate to remove uncertainty on notional and rate deliverable on expiry.
  • Credit Risk

    • By entering into a bilateral contract a client is taking on a credit risk to Investec Bank plc. In the event that Investec should default on its obligations or become insolvent a client may not receive back the full value of their transactions.
  • Volatility Risk

    • In adverse market conditions volatility can increase and this will lead to greater market risk. In normal market conditions volatility in FX markets will vary between currency pairs. Major currency pairs such as G10 currencies offer more stability than emerging market currencies where volatility is more significant.
    • In more volatile market conditions clients may be subject to a wider spread with regards to pricing available.
    • Changes in volatility will have an impact on the mark to market of a derivative contract.
  • Liquidity Risk

    • FX markets are generally very liquid however similarly to volatility this can depend on currency pair. G10 currency pairs will offer greater liquidity than more obscure emerging market currency pairs.
    • In markets with less liquidity clients may be subject to a wider spread with regards to pricing available. 
  • FX Risk

    • Clients entering into FX derivative contracts with Investec are exposed to direct FX risk as fluctuations in the market will have a direct impact on the client's market risk as outlined above. 
  • Concentration Risk

    • Concentration risk is not applicable to these products.
  • Conflicts Risk

    • Investec may take and/or hold positions that conflict with those of our clients, more details around the treatment and execution of client orders can be found in the Order Execution policy which can be found on the website.
    • Conflicts arising, from Investec’s business model, such as the one noted above, are managed through internal controls and process and is detailed in the Conflicts of Interest policy which can be found on the website.
  • Transparency

    • FX Spot markets are very transparent with up-to-date pricing available online. Pricing around other FX instruments such these structured FX derivatives is less transparent.
    • Where markets are less transparent it can be challenging to form an independent assessment of a contract's fair value.
    • In line with regulatory requirements the Investec website will provide indicative pre-trade cost disclosure for all OTC FX derivatives.
    • Additionally, transaction-specific post-trade cost disclosures will be provided for all OTC FX derivatives on trade confirmations.
  • Margin Risk

    • Investec may, from time to time, request that a client posts collateral against a trading position, subject to the specific arrangements agreed between Investec and client. These funds are required in order to protect Investec from losses should a client default on their obligations or become insolvent.
    • Funds held by Investec as collateral will be held in one of two ways depending on a client’s MiFID Classification:
      • MiFID Retail clients: Collateral held against positions opened with MiFID Retail clients will be held on deposit by Investec as ‘Banker’. Clients must sign a Collateral Deed in order that Investec can use these deposited funds to offset their exposure to the client in case of client default.
      • MiFID Professional clients: Collateral held for MiFID Professional clients will be held in a margin account under a Title Transfer Collateral Arrangement (“TTCA”). A TTCA is a legal arrangement that gives Investec ownership of the client's margin funds whilst they are in possession of the Bank. Investec can therefore utilise these funds as required for liquidity or investment purposes as is deemed necessary.
    • A client that has funds held by Investec as collateral is also exposed to the credit risk outlined above.
  • Contingent Liabilities

    • Contingent Liabilities are not applicable to these products.
  • Exit Costs

    • These products do not have explicit exit fees that are payable above and beyond a client's mark to market and contractual obligations should they wish to close a position early, however there may be costs involved in this process depending upon market conditions at the time the client wishes to exit. A client may not be able to redeem full original value of the contract.
    • A client's ability to exit early will also be dependent upon the liquidity of the market at the time, should a market be illiquid at the point of early exit then the exit costs are likely to be more significant.
    • There is no cost associated with exiting a product on expiry or at the end of its recommended holding period provided a client satisfies their contractual obligations.
  • Leverage

    • Net sold optionality creates a gearing effect on both risks and returns.
  • Interest Rate Risk

    • Clients entering into contracts such as these are taking on an indirect Interest Rate risk. Changes in interest rates will have a direct impact on FX Forward pricing, as such fluctuations in interest rates will have an impact on the market risks facing clients.