FX Link: Offset FX Hedge

CME FX Link is a CME Globex-traded basis spread, traded as a differential, between FX futures and OTC spot FX. The spread results in a simultaneous execution of FX futures cleared by CME Clearing, and OTC spot FX, subject to OTC documentation and credit relationships.

Let’s review using FX link to offset an existing FX hedge.

Using FX Link to Offset an Existing FX Hedge

A bank buys spot USD/CAD on Monday, February 26 for delivery Tuesday, February 27 because Canadian dollars (CAD) settle to US dollars on a T-plus one business day basis.

Then, the bank hedges the resultant short CAD exposure by purchasing March CAD/USD futures that expire Tuesday, March 20 for delivery Wednesday, March 21. Thus, creating a neutral market position with basis risk from February 27 settlement date to March 21, the settlement date of the futures position.

Later that day, the bank decides to convert its hedged position from a neutral market position with basis risk into a market neutral position without basis risk.

The dealer bank has two alternatives.

First, the bank could sell CAD in the spot market and then simultaneously sell March CAD/USD futures to unwind the original hedged position. However, such an approach requires the bank to separately execute two transactions, introducing execution risk.

Alternatively, using CME FX Link, the bank could buy the March USD/CAD FX Link spread on February 26 which simultaneously sells March CAD/USD futures and sells USD/CAD OTC FX spot.

This is because CAD is an inverted pair – meaning the futures are quoted inversely to the OTC dollar/CAD convention.

So, buying the spread, one needs to sell futures and sell spot simultaneously.

By using FX Link, the trader has removed the basis risk associated with the original hedge by offsetting both the original position and the hedge via a single efficient FX Link spread.

Conclusion

We have reviewed one scenario where market participants could use FX Link to manage risk and positions across OTC FX spot and CME FX futures, seamlessly connecting the two markets. CME FX Link allows you to better manage and optimize margin and credit lines across CME FX futures and OTC spot FX transactions.