Blog

FX swaps are one of the most widely used instruments in currency management. The omnipresence of swaps and forwards in fx-risk-management is best understood by glancing at recent estimates by the Bank for International Settlements:

“FX swaps and forwards had reached the $130 trillion mark in late 2024. The rise in the notional value of FX derivatives was driven mainly by greater positions in FX swaps and forwards” — BIS

‍

A currency swap is equivalent to a package of forward contracts. On the one hand, an amount of currency is bought or sold against another currency with a given value date. On the other hand, the reverse trade takes place, but with a different value date. 

FX swaps are used in a variety of companies, asset managers and banks with different hedging-strategies. In 2023, the Riksbank —the Swedish central bank— hedged part of its foreign exchange reserves with swaps, selling USD and EUR against SEK.

This blog discusses, in the context of corporate fx-risk-management, the following topics:

• Adjusting the forward position to the underlying commercial settlement

• The costs and risks associated with manual swap execution

• How Currency Management Automation reduces costs and risks

‍

Using swaps to adjust currency hedging

Ensuring a perfect match between the settlement of commercial transactions and the corresponding FX hedges is next to impossible. 

To bridge the gap between these positions, swapping is necessary. Swaps allow treasury teams to:

• Perform early draws on existing forwards

• Roll over existing forward positions

Consider the following ‘early draw’ example. Company A  has an open forward position to buy $1,000,000 against EUR at a forward rate of EUR-USD 1.1100. The position was taken several months before to hedge a forecasted commercial exposure.

Company A now faces a payment of $100,000 related to that exposure. Swapping is therefore required to ‘draw’ on that forward position. There are two ‘legs’ this transaction: 

• The near leg. It consists, in this case of a spot transaction: the firm buys $100,000 against EUR

• The far leg. The firm simultaneously sells $100,000 against EUR, at the value date of the forward

Thanks to this transaction, the treasury team not only obtains the required amount of dollars on the spot — its forward position at the original value date is also automatically adjusted. Quite naturally, FX gains/losses will be involved, as the exchange rate has shifted.

This simple example illustrates the enormous practical value brought by swaps. As companies execute such transactions on many thousands of occasions on any given day, we can understand why total FX forwards and swaps stand at more than $130 trillion. 

‍

‍

The costs and risks associated with manual swap execution

Treasurers know it too well: swapping is complex and resource-intensive. Day in, day out, we encounter situations that show the stress members of corporate-treasury teams find themselves in as they execute the indispensable FX swap transactions:

• Manual checking of payments. Several times a day, members of the treasury team log on to the Treasury Management System to manually retrieve cash balances with payments and collections in different currencies.

• Manual selection of liquidity providers. The amounts are checked prior to the execution of the corresponding swaps through a multilateral FX trading platform. Liquidity providers are manually selected. 

• Lack of traceability. Lack of proper traceability hinders the possibility of assessing hedging performance (including the forward points impact) as swaps are manually traced back to the corresponding forward position.

• Operational risk. The entire workflow relies on emails that circulate back and forth with spreadsheets carrying potential input errors, copy & paste errors, and formatting and formula errors—on top of email risk.

‍

When manually executed, the process of using FX swaps to adjust the firm’s hedging position can be so cumbersome that currency managers may fall victim to the siren song of so-called flexible forwards. Here’s an example.

A Canadian importer of vaccines and other medical inputs hedges its CHF-denominated purchases with flexible forward contracts. The treasury team likes the flexibility of fully or partially settling the forward contract during one month for the same rate. 

But what is not fully transparent to the team is the high costs of the process. This is because, as the company’s liquidity providers protect themselves from FX risk, they set the exchange rate at a date that is more convenient to them in terms of forward points, i.e., the difference between the forward and the spot rate. 

If the company needs funds before expiry, it pays the desired amount of Swiss francs at the CHF-CAD rate of the value date of the forward contract, instead of the lower rate that would correspond on account of the Canadian dollar’s forward discount to CHF (about 3.34% for 12 months).

Swap automation to the rescue

Faced with an array of costs and risks, beleaguered members of the treasury teams can turn to API connectivity to solve the many operational and cost-related challenges related to swap execution. 

Going back to the Canadian firm cited above, we backtested an alternative way of letting the company draw on its currency forwards: swap automation. The savings are material: they represent about 0.20% of the firm’s traded volume, which is equal to a third of the savings from forward points in a layered FX hedging program (not discussed here).

And that’s only for one currency pair. Add the other currency pairs, and the proposed connectivity to a multi-dealer corporate FX trading platform, and pretty soon we are talking hundreds of thousands of (Canadian) dollars in savings. As Ignacio Recalt, Treasury SaaS and Payments Product Owner at Kantox says: 

“Swap automation frees up resources and removes operational and other risks. Whether they need to anticipate or roll over FX forwards linked to payments/collections, treasurers can execute the process in one click.”

With complete visibility and control, the finance team obtains:

• Swift integration with ISO20022 

• Traceability between swap legs and the underlying forwards

• Granularity in terms of FX gains and losses and forward points 

• IBAN and BIC setups integrated with the ERP and TMS

‍

‍

The illustration below shows how PowerBI displays the perfect traceability between swap legs and the underlying FX forwards of a hypothetical user: 

‍

‍

Conclusion. Treasurers of the world: automate!

Although it represents only one of the many tasks that treasury teams execute on a daily basis, the process of swap automation neatly encapsulates the benefits of API-centred Currency Management Automation:

• Lower hedging costs

• Reduced levels of stress

• Reduced operational risks

• More time for value-adding tasks

• More incentives to ‘embrace currencies’

If you are struggling with the process of swap execution and all the manual tasks that it involves, take a look at our comprehensive report Optimising Cash & fx-risk-management or 👉 send us your data and FX challenges here.

‍