This is weird

Two foreign exchange firms have been accused of turning the screw on struggling retailers by abruptly changing the terms of currency cover after dramatic fluctuations in sterling.

The Original Factory Shop, a discount chain with 168 stores and 2,450 employees, is complaining to the Financial Conduct Authority after Ebury Partners and Global Reach Group altered the terms of their currency hedging contracts.

The retailer, which sells toys, small electrical appliances and garden equipment, imports a significant amount of stock and had two forward currency contracts worth about $16.5 million with the two forex firms.

Such contracts are supposed to give businesses protection from currency movements, which can erode profit margins. The retailer said that its contracts, which were taken when sterling was worth $1.30, have been changed leaving it exposed to further sterling falls.

It is understood that in the middle of March, as sterling fell to $1.16, Global Reach demanded additional payments and threatened to cancel all forward contracts. Ebury sent a “blanket email” to terminate its currency contract.

How have those contracts changed? Assuming that the FX contracts were to protect them against a fall in sterling – and they’d not have been doing otherwise, would they? – then they’d be wildly in the money and therefore no further margin would be necessary.

And it boggles the mind to think that an FX firm is going to try to renege.

The only other thing I can think of is that the price to roll over into a future time period that protection has risen. Which seems fairly logical, as the position is now well in the money. Also, a pretty weird thing to complain about. Even, if they’re trying to protect at the current level the price will still have risen because volatility has.

That is, it’s very difficult to understand what is being complained about. Reneging seems so unlikely……

11 thoughts on “This is weird”

  1. As reported, it makes no sense unless the contracts had expired. But if the contracts had expired then there are no grounds for complaint

  2. I was thinking also that rolling the hedges forward might be the reason but IIRC from way back, fx swap rolls, when the forward end becomes spot then it and any additional exposure is covered with no cash flow and the swap/forward points are reflected in the new forward side. This then is rolled again in say 2 weeks or a month. I may remember this totally wrong.

  3. The Meissen Bison

    It’s probably a case of a journalist not understanding what he’s writing about.
    The retailer said that its contracts, which were taken when sterling was worth $1.30, have been changed leaving it exposed to further sterling falls.
    A forward contract can’t be changed at the whim of one of its parties.

  4. TMB, not exactly. An FEC exchange rate is valid for the duration of the contract. Once the contract matures it is no longer valid. If the contract is extended, then the rate will change to spot + forward points based on the date on which the contract is extended and the extension period.

    Either the retailer doesn’t understand or the journalist doesn’t understand. My money is on the journalist. It’s a non-story, the contract only protects against currency movements for the duration of the contract.

  5. Bloke in North Dorset

    I don’t know anything about those sorts of contracts, so no such thing as a stupid question time: is there likely to be a force majeure clause? If so could the current pandemic be used as a trigger?

  6. BiND – it is not exactly unusual, especially in recent years, to see much larger swings than $1.3 to $1.16. I am not sure that force majeure would cover a pandemic where there is still a considerable amount of cross-border trade taking place. It might work in the event of a war or something truly catastrophic – a 1000 ton meteorite etc. Not even climate change would justify it

  7. The Meissen Bison

    Henry: An FEC exchange rate is valid for the duration of the contract

    That was my meaning – thereafter everything is renegotiable. My point, I think, was rather that the chap writing this up understands this less well.

  8. BiND, an FEC is not that sort of contract in that there are no force majeure clauses. It is merely a mechanism for companies to fix exchange rates for a given period to mitigate against large currency swings. Back when I was involved in this sort of thing, the ZAR was quite volatile, especially after they defaulted on their international loan payments. I used to work for a large mining and industrial company administering such contracts (currency & precious metals). There were a couple of guys in the dealing room striking FEC deals with various banks as well as arbitrage deals based on a schedule of imports and exports. The FECs were established on an almost daily basis to fix the exchange rate for either a given fixed future period or a fixed future date. Extensions/cancellations would either cost the company or make them a profit depending on which way the currency had moved in the intervening period. More a case of mitigating risk and ensuring that the amount to be received/paid out is known in advance rather than waiting until date of payment and hoping for a favourable exchange rate.

  9. My guess, based on lack of info in article:

    The Original Factory Shop purchased Futures not Options and FX traders exercising margin call

  10. OK but surely they were buying dollars forward, and buying into a declining price. It’s not as if the price was moving against them.

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