What are they & when can they be used?
In the most basic terms a forward contract is where you buy now and pay later.
A client can secure a live rate today for an extended period of time, 3-6-9months, up to a year+.
As standard a 5% deposit is paid upfront which is used toward the final drawdown at the end of the forward. The deposit amount across the industry can vary and is usually in the 10% region, however at Ocean Capital Exchange 5% is the standard level and we can apply for 0% in some cases.
You can drawdown from a forward contract at any time from the day it is booked. A client simply requests the amount they need to drawdown from the forward or arranges the drawdown amount on their online platform. A transaction receipt is then sent out with the amount that needs to be sent in to fund the payment and as soon as the funds arrive, the payment is sent out.
There are several reasons why people use forward contracts but mainly they are used to take advantage when a rate is particularly good and to avoid market volatility causing the rate to move out of favour, locking in profit and mitigating risk.
The last few years have shown how unpredictable the markets can be. The back and forth and uncertainty of Brexit negotiations and the panic caused from the pandemic have been two major factors which have caused a huge amount of volatility. When there is a lot of volatility forward contracts can be very effective.
To give an example, at the start of 2020 we had finally managed to get a Brexit deal in place and the markets seemed to be settling a bit more following the previous years of volatility caused by Brexit. On average between Jan-Mar 2020 the average USD rate was around the 1.30 mark, a fair bit higher than where the rate was for most of the previous year. On March 9th 2020 when the rate hit around the 1.32 level we started hearing reports that Covid was in the UK and cases were rising by the day. From March 9th-19th as the Covid situation worsened we saw the rate fall from 1.32 down to one of the lowest levels ever at 1.14!
Of course no one could predict a global pandemic however as news was coming out there was much uncertainty around the severity of the situation and when there is uncertainty, there is volatility.
In this situation many clients looked at forward contracts to protect their exposure. Securing a rate when the market was around the 1.30 level, many clients saved thousands as the markets dropped. Hypothetically, if you were to book $50k for the month of March the difference between the highest rate and the lowest would have been around £6,000.
By booking a forward contract, clients will secure the rate at the higher level, so where the live rate had dropped down to 1.14, the clients were getting a rate of 1.30+ from their forward.
When speaking to clients about forward contracts the main worry is always, ‘if the rate improves will I still have to use the rate I booked on the forward?’ The answer to this is yes, once you book a rate on a forward you have to honour this rate.
It is impossible to predict whether the rate will improve or not, this is why many clients will only look at securing part of their exposure on a forward. This way if the rate does improve a client can book on spot, then if the market drops below the rate secured on the forward you can arrange a drawdown. This way your overall average rate will improve.
If the rate falls away from the time you book the forward contract and it does not recover you will have secured part of your exposure and can split your payments, part on spot, part from a drawdown this again will improve the rate compared to simply booking on spot.
For more information on how we can help protect your business from dramatic currency fluctuations by putting a simple hedging strategy in place, get in touch today.
(t) 0207 183 2026