In an uncertain world, derivatives are key to managing currency risk
Managing exchange-rate risk is a critical tool that is essential for any organisation, local or multinational, focused on stability or growth
The rand has a history of volatility — appreciating one day and weakening the next, mainly taking its direction from the performance of the global economy, specifically the relative performance of emerging markets, the SA economy, commodity prices and political developments.
As a free-floating currency the rand’s value in relation to other currencies is determined by demand and supply, strengthening when its demand increases and depreciating when its demand drops. These fluctuations, and sometimes relative stability in the value of the rand, may require companies, investors, traders, importers and exporters to use foreign exchange derivatives to hedge themselves against the volatility.
While foreign-exchange derivatives have been in existence for more than 40 years, the JSE launched its own currency derivatives platform in June 2007, which allowed for the on-exchange trading of currency futures and options.
The JSE platform was introduced as an alternative to the over-the-counter (OTC) markets, to provide market participants with a transparent and regulated trading environment that does not require SA Reserve Bank approval and complicated paperwork for entering and exiting trades.
These derivatives are essentially an insurance cover that enables users to protect themselves against currency risk while also offering the opportunity to speculate on movements in the underlying foreign exchange rates.
All the trades that are executed through the JSE are matched daily by a world-class clearing house known as JSE Clear, which acts as a counterparty that ensures that every derivative contract traded, is in fact settled.
The most commonly traded foreign-exchange derivative is the futures contract, which enables a user to buy or sell a specific quantity of foreign currency at a predetermined exchange rate at an agreed point in the future. On the other hand, currency options grant the purchaser the right but not the obligation to trade a currency at a predetermined date in the future at a pre-arranged price, regardless of where the underlying market is trading.
In most cases, the buyers of currency futures, who are typically importers, agree to purchase US dollars and sell rand at a point in the future with the objective of locking in a specific exchange rate.
The JSE offers a range of currency derivatives across both futures and options, which can be used to hedge currency risks. One of the differentiating offerings is the ability to select a bespoke expiry date, known as an Anyday contract, for both futures and options.
In the drive to ensure the JSE provides alternative offerings to the over-the-counter space, one can create a bespoke option, which allows for the listing of strategies to meet the risk being hedged. This speaks to our focus and role as the JSE in innovating for our market, where we constantly assess the needs of the market and create solutions to meet them.
Managing exchange-rate risk is a critical tool that is essential for any organisation, local or multinational, focused on stability or growth. To do so it is crucial to invest in understanding how an organisation could be impacted by risks and evaluate various strategies available to reduce or avoid these risks.
The Covid-19 pandemic has highlighted to the world the importance of being prepared to protect your business in the event of unforeseen developments. The financial impact experienced by individuals and companies alike due to the pandemic, has left an indelible mark across the globe.
With the pandemic still hanging over the global economy and delays in vaccine rollouts, there is no telling how the global economy and currency markets are going to be affected. This is a time where we need to take a step back and reassess the risks we are exposed to and take the necessary steps to reduce or avoid them.
So, can you risk not managing your exchange rate risk? The answer is no if your business is exposed to global trade.
• Mabiletsa is manager of currency derivatives at the JSE.
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