What future for Foreign Exchange Options?

Fri 24 Mar 2017
Posted by: IOE&IT News

Currency exchange board

Article by Lesley Batchelor OBE, director general of the IOE&IT

It’s perhaps a sad irony that whenever we most need a financial product such as home or health insurance, a loan or some other form of credit, that can be the time when it’s denied to us.

Given this somewhat cynical view of financial services, it’s not really surprising that rumours have been growing in response to the decisions by certain financial services companies to withdraw from the Foreign Exchange Options (FX Options) market.

Foreign Exchange ‘options’ are a long-established facility that enables companies that regularly buy or receive funds in foreign currencies to manage the risks of currency fluctuations by fixing a future price on the currency they expect to receive or require.

So it came as a surprise when at least one major UK company announced that it was withdrawing from the FX options market.

Some observers have looked to market conditions for an explanation and it is certainly true that it has come at a time when movements in major currencies have been particularly difficult to predict and world prices for key commodities such as oil have continued to move erratically.

In these circumstances, is it really surprising to see service providers becoming reluctant to keep carrying the risk? And is this news the start of more changes for the financial exchange market? When considering these questions it is important to remember that the decision relates only to options - the most flexible facility where the client has the right to buy at a future date, with no obligation. Companies exposed to foreign exchange risks can still avail themselves of forward contracts, where they are tied in to the exchange contract.

FX options, in particular, carry a greater level of risk for those who provide them. They offer the client a choice about whether to take the offer when it matures or not and the provider stands to lose heavily if market prices move significantly in the wrong direction, with less chance of reaping a benefit if rates move the other way. For this reason, FX options tend to be a relatively expensive choice, particularly for smaller businesses.

In the light of this, the move away from FX options could just be a response to customer demand, rather than any real concerns about conditions in the exchange market itself.

But the developments ought to serve as a prompt to credit managers to review their management of currency fluctuations and consider the most appropriate actions in view of the continuing uncertainties.

And with ongoing uncertainties about Brexit, the Trump Presidency and the continuing difficulties in the Eurozone, there do seem to be plenty of reasons to expect changeable conditions to continue for the foreseeable future.

It seems we can be certain of only one thing: that we can’t be certain about anything.