The difference between hedging developed and emerging market currencies can be summed up as a “yes” answer to any of the important questions that may arise. For developed market currencies, for example, you can answer “yes” to questions such as “can I trade a large amount?”, “Can I make a forward contract or an option on currencies?”, “Can I trade more long term?” or “can I carry out transactions at any time of the day?” However, when exposed to emerging market currencies, corporate treasuries face more challenges and must consider different factors.
Those trading a lot and hedging investors should know what time of day to trade to ensure the best available liquidity, even if that involves hedging Asian currencies by US companies during Asian trading hours. Additionally, there may not be an FX options market available and, in the case of frontier market currencies, you may not even have access to a forwards market.
NDF and emerging markets
Emerging market currencies often have currency controls in place, restricting the vast majority of foreign market participants from trading traditional currency deliverable forward contracts. As an alternative, these participants use undeliverable forward contracts (NDFs) as a mechanism to gain exposure in foreign countries. NDFs are the preferred instruments of speculators. The speculator buys the foreign currency and sells USD for six months, for example. At the expiration of the contract (or just before), the contract is “adjusted” at the current rate and is settled net in USD. Most importantly, foreign currency never changes hands.
The advantage for companies
The use of NDFs is not limited to speculators, as corporate treasuries also have access to NDFs to hedge their exposure to foreign currencies. In some circumstances, depending on your side of the market and the forward price curve, NDFs can be a good instrument to consider. However, in the vast majority of cases, companies must accept delivery (or make payment) in foreign currency. With the correct documentation, companies are in a unique position to access the onshore market for deliverables, decide which market provides the most effective hedge through the comparison of forward curves for each instrument option, and choose to trade a contract. Forward deliverable to settle in foreign currency if required.
Demand an efficient workflow
When trading in emerging markets, one question that should be answered with a resounding “yes” is how you can actually execute the trade. Companies have been avid in adopting electronic FX trading in developed markets for all the benefits and efficiencies this technology provides. Some of these benefits include:
- Reduction of errors in the transaction
- Ability to request a competitive price
- See in real time how much it would cost to negotiate with one counterpart compared to another
- Confirmation, matching and settlement
- Easy calculation of the transactions won / portion of the portfolio of the bank with which it operates
Companies should not be expected to give up these benefits and revert to an inefficient workflow. Some platforms cannot access local banks that trade emerging market currencies.
The continuing trend toward truly centralized corporate treasury, coupled with an ever-expanding list of emerging markets. Companies have exposure, efficiency, and automation in all areas of FX transactions helps reduce operational risk. The counterparty and the market. By effectively managing risk across the enterprise, treasuries can mitigate exposure to potential losses, improve cost-effectiveness, increase profitability, and identify new business opportunities. When it comes to adopting an electronic trading platform to better serve local FX markets, the answer is a simple ‘yes’.