FX Link can be used to manage cash flows when an IMM-dated FX futures contract is used to hedge FX exposure inherent in a non-IMM dated transaction. This combines the efficiencies of FX futures with accuracy in cashflow timing.
Scenario
An Australian commodity exporter is making a non-IMM dated forward delivery of the commodity for USD. To protect against a USD depreciation versus AUD in the interim period, the exporter seeks to hedge the dollar exposure related to the delivery.
OTC approach
- Buy a notionally equivalent, non-IMM-dated OTC AUD/USD forward to the exact date to match the non-IMM dated commodity forward to hedge the USD exposure, effectively converting the USD to AUD.
- Potentially more expensive given the custom non-IMM dates, introducing counterparty risk and offering no capital benefit
- Incur applicable prime brokerage (PB) fee for establishing the FX and bid-ask spread charged by the PB/liquidity provider (LP).
FX Link approach
Step 1: Buy a notionally equivalent, IMM-dated AUD/USD futures contract from CME Group for the same corresponding underlying delivery month of the commodity forward.
Step 2: Two business days prior to the delivery date, sell the AUD/USD FX Link spread. This transaction is selling an offsetting IMM-dated AUD/USD futures contract while simultaneously buying AUD/USD spot.
- Mitigates currency risk of the non-IMM-dated commodity forward at a potentially lower cost than an OTC transaction, while receiving full central clearing party benefits, futures position netting and optimizing capital relief efficiencies.
- Incurs applicable PB fee for spot leg, FCM and CME Group exchange fee for the futures leg and bid-ask spread on the FX Link spread.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
