OTC FX Derivatives - key risks and features
FX Option (sell), Calendar Ratio Forward, Accrual Forward, Accrual Forward Extra, Extendible Forward, TARF
These products cannot be considered a hedge as they contain features which mean they may terminate prior to expiry, therefore leaving a user unhedged and needing to seek cover in the prevailing Spot market. The use of these products is restricted to MiFID Professional clients.
Key risks and features
- 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.
- Depending upon the underlying reference price on expiry these products may terminate leaving the client with no hedge. Clients may then opt to trade in the prevailing Spot market.
- 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.
- 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.
- When dealing in more volatile markets, the likelihood of a knockout event is increased.
- 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.
- 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.
- 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 is not applicable to these products.
- 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.
- 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.
- 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.
- 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 are not applicable to these products.
- 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.
- These FX derivative products all contain leverage, the impact of this is that dependent upon market conditions on expiry the client may be obliged to transact in greater volume at a pre-defined rate.
- It is possible that in some cases the products may contain “knock-outs” which will mean that should a certain pre-defined event occur the product will terminate. This could mean that a client is left seeking any required FX in the prevailing Spot market.
- A client using leverage will not have the certainty offered by an unleveraged product as the rate achieved and volume transacted will not be known until expiry.
- 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.