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

What is a forward sale?

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

Thus, in the context of converting Swiss francs into euros, a forward sale commits the bank’s client to sell a certain amount of Swiss francs to the bank each month in exchange for a certain amount of euros, at a rate agreed in advance in the contract.

Typically lasting 3, 6 or 12 months, a forward sale allows individuals to protect themselves against any adverse fluctuations in the exchange rate between the two currencies, although it also prevents them from benefiting from any favourable movements. By locking in the exchange rate, a forward contract offers budgetary predictability that appears attractive at first glance.

How does a forward sale work?

How it works

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

• the spot rate, i.e. the rate immediately available for conversion;
• the lending and borrowing rates for the relevant currencies over the terms specified 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 specified future date, in exchange for which it will receive an equivalent amount of euros at a pre-agreed forward rate.

Example

To hedge against exchange rate risk, a cross-border worker enters into a forward contract with their bank. The bank thereby undertakes to apply a fixed forward rate to each of the client’s remittances in Swiss francs for the next six months. For example, six remittances of CHF 3,500 at a rate of 0.9.

In return, the customer undertakes to pay the agreed sums on the specified dates, namely CHF 21,000 over a period of six months. In practice, for each monthly payment of CHF 3,500, the bank credits the customer’s account with €3,150, amounting to a total of €18,900 at the end of the predetermined period.

Forward sales: numerous limitations and drawbacks

An expensive product

Although it may appear to be an effective way of hedging against exchange rate risk and therefore a source of savings, forward selling actually comes at a very high cost. 

In fact, to benefit from the cover it provides, the customer should expect to pay:

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

As regards the latter, it is worth bearing in mind that it may simply wipe out the protected amounts in the event of an adverse movement in the exchange rate. 

Good to know: Over the course of a year, for a customer transferring 5,000 CHF each month, the bank could charge up to 900 euros in currency conversion fees!

Furthermore, if, unfortunately, the Swiss franc were to appreciate in value this year, the client would then lose out on both counts…

A risky product

A forward sale contractually obliges the customer to make monthly payments to their bank. However, life’s uncertainties can unfortunately prevent them from meeting these payments. 

Family issues, an accident, an unexpected expense… However legitimate the reasons for non-payment may be, they 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, individuals may find themselves having to exchange their euros for Swiss francs, only to exchange them back into euros as part of their foreign exchange guarantee, thereby incurring exchange fees twice over!

Finally, although some banks mention the possibility of cancelling a forward contract in the event of redundancy, this is not a free process. By reading the general terms and conditions of the forward contract carefully, the customer 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 alternatives

Precautions to take

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

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

• Limit the term of the forward sale to three months. This short duration will allow you to back out if any problems arise. You should definitely avoid terms of six or twelve months.

• Before signing, make sure you are aware of any hidden terms and conditions. Don’t hesitate to ask any difficult questions regarding the conditions for terminating the contract, the cost of doing so, and the procedure to follow in the event of redundancy, non-payment, etc.

An alternative to forward sales

Expensive, risky… The forward sales service offered by banks is not the ideal solution for hedging 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 offers much better rates and is far more transparent!

Please note: As a broker dealing with private individuals, b-sharpe does not offer any exchange rate guarantees. 

b-sharpe customers can therefore lock in the exchange rate in real time by calling our operations department during our opening hours. Once the rate has been locked in, customers have 48 hours to transfer the funds, thereby protecting themselves against exchange rate fluctuations between the time the funds are sent from their bank and the time they are received by b-sharpe.