Forward sales: the ideal hedge against currency risk for private individuals?

What is a forward sale?

A forward sale, or exchange rate guarantee, is a contract signed between an individual and a bank, allowing the individual to lock in the exchange rate that will apply to their currency conversions over the coming months.

When converting Swiss francs into euros, a forward sale therefore commits the bank’s client to sell a set amount of Swiss francs to the bank each month in exchange for a set amount of euros, at a rate fixed in advance in the contract.

Typically running for 3, 6 or 12 months, a forward sale allows individuals to protect themselves against any unfavourable movement in the exchange rate between the two currencies, while also preventing them from benefiting from any favourable movement. By freezing any rate fluctuation in this way, the exchange rate guarantee offers attractive budgetary visibility at first glance.

How does a forward sale work?

How it works

To determine the forward rate applicable to the exchange rate guarantee it offers its client, the bank relies directly on information already available on the market, namely:

• the spot rate, i.e. the rate immediately available for conversion;
• the lending and borrowing rates for the currencies concerned, over the terms set out in the contract.

It is on the basis of this data that the bank offers a forward exchange rate, which is therefore not based on a forecast of the spot rate at the contract’s maturity.

When entering into a forward sale, the bank uses a futures contract on the foreign exchange market, under which it undertakes to sell a certain amount of Swiss francs at a given maturity date, in exchange for which it will receive an equivalent sum in euros, at the forward rate agreed in advance.

Example

To guard against exchange rate risk, a cross-border worker enters into a forward sale with their bank. The bank thereby undertakes to apply the same forward rate to each transfer of Swiss francs made by its client over the next 6 months. For example, 6 transfers of CHF 3,500 at a rate of 0.9.

In return, the client undertakes to provide the agreed sums on the specified dates without fail, i.e. CHF 21,000 over a period of 6 months. As a result, for each monthly payment of CHF 3,500, the bank credits its client’s account with €3,150, for a total of €18,900 at the end of the predetermined period.

Forward sales: numerous limitations and drawbacks

A costly product

Although it may look like an effective solution against exchange rate risk, and therefore a way of saving money, a forward sale actually comes at a very high cost.

Indeed, to benefit from the protection it offers, the client should expect to pay:

• significant handling fees, which generally amount to around a hundred euros at most banks;
• the margin (often substantial) that the bank allows itself.

As for the latter, it is worth bearing in mind that it can potentially wipe out the protected sums entirely in the event of an adverse movement in the exchange rate.

Good to know: Over a full year, for a client transferring CHF 5,000 each month, the bank can charge up to 900 euros in exchange fees!

Furthermore, should the Swiss franc unfortunately appreciate over the course of that year, the client would then lose out on both fronts…

A risky product

A forward sale contractually obliges the client to make monthly payments to their bank. Life’s uncertainties, however, can unfortunately prevent them from honouring these payments.

Family circumstances, an accident, an unexpected expense… However legitimate they may be, the reasons for a missed payment will matter little to the bank, which will then be entitled to claim payment of penalties. Making ends meet can then prove difficult…

Furthermore, depending on the complexity of their professional situation or the source of their income, an individual may find themselves converting their euros into Swiss francs, only to convert them back into euros under their exchange rate guarantee, thereby paying exchange fees twice over!

Finally, although some banks state that the forward contract can be cancelled in the event of redundancy, this process is not free of charge. On reading the terms and conditions of the forward sale carefully, the client will realise that the further away the contract’s maturity date is, the higher the penalties will be for cancelling it due to redundancy.

Forward sales: advice and an alternative

Precautions to take

If, despite these warnings, you still wish to take out a forward sale, here is our advice:

• Limit the amount you commit to an exchange rate guarantee to 30% of your income. If the contract does not allow this (for example, because your income is insufficient), simply do not take out a forward sale. For the remaining 70%, or for the whole of your salary, consider an online currency exchange service offering preferential rates.

• Limit the term of the forward sale to 3 months. This short duration will allow you to change course should a problem arise. Be sure to avoid terms of 6 or 12 months.

• Make sure you are aware of any hidden conditions before signing. Don’t hesitate to ask the awkward questions regarding the conditions for cancelling the contract, the cost of doing so, and the procedure to follow in the event of redundancy, missed payments, and so on.

An alternative to forward sales

Costly, risky… The forward sale service offered by banks is not the ideal solution for protecting against exchange rate risk.

However, b-sharpe offers private individuals a more cost-effective, secure and equally efficient alternative through its online currency exchange service, which is far more attractive in terms of margins and much more transparent!

Good to know: As a broker for private individuals, b-sharpe does not offer any exchange rate guarantee.

b-sharpe clients therefore have the option to lock in the exchange rate in real time by calling our operations team during our opening hours. Once the rate has been locked in, clients have 48 hours to transfer the funds, thereby protecting themselves against exchange rate fluctuations between the funds being sent from their bank and their receipt by b-sharpe.