Credit Exposure management in Foreign Exchange
Financial Institutions offer forward forex products to their clients as part of
currency risk management platform. This is an integral part of currency exposure
mitigation which allows corporate clients to hedge anticipated currency payables
or receivables and thereby protect profit margins. A mitigate to manage the resulting
credit risk typically involves collecting a small percentage of the outstanding
contract as margin or collateral. As the Financial Institutions compete, the amount
of margin collateral collected faces downward pressure and is typically less than
5% - often closer to 2% or even less.
Currency markets have recently been unpredictable and most major currencies have
seen unannounced wild volatility in short bursts. In the past few years, weekly
(or sometimes daily) volatility has exceeded 5%. During times of such volatility,
the foreign exchange market sees spikes in trading volumes and typically Financial
Institutions can capitalize on revenue opportunities from higher volumes. At the
same time, inadequate management of credit risk can be devastating and without the
appropriate reporting and controls, massive losses can ensue very quickly.
Without the right tools, the complexity of measuring credit risk leads to delayed
reporting. Non-integrated systems prevent decision-makers from seeing current and
accurate information which is especially dangerous during volatility. Financial
Institutions that offer forward products will have many outstanding forwards with
varying value dates. In addition, clients may transact in multiple currency pairs
and even hold margin collateral in multiple currencies. Performing mark-to-market
valuations of transactions is complicated and requires value-date extrapolation
of forward discount/premium points. Measuring client credit risk and composite credit
risk can be very challenging when rates are swinging
Datasoft FxOffice and Credit Risk Management:
Datasoft Fxoffice Suite runs on a single platform and all transactions are transparent
to risk management and financial modules. With the ability to see in real-time client
margin deposit balances, outstanding deals and partly settled transactions, FxOffice
can report the quantum of credit risk for each deal. Moreover, the streaming of
real-time forex rates allows decision-makers visibility into each client’s margin
position by performing mark-to-market processes on every transaction and all currency
deposits. The result is a powerful up-to-the-second margin monitoring platform. Credit
managers can utilize Datasoft’s business modeling tools to define limits and alerts
as well as Datasoft Analytics to view overall composite risk and granular client
credit risk on demand.
As currency risk hedging strategies get more elaborate, the manner in which forward
transactions are booked can get complex. Often, take-profit or stop-loss scenarios
will create a set of forward transactions in different currency pairs and in different
directions. The quantum of a single client’s volume of outstanding transactions
is very relevant to credit risk management. Quantum is often ignored in calculating
credit risk so long as cash margin collateral exists; this is a dangerous pitfall.
Depending on the nature of clients, Financial Institutions will extend to clients
forward credit facility lines to control the quantum of risk. Datasoft has integrated
into its platform the ability to calculate a forward-line quantum using a number
of methods as follows:
- Gross Line: all outstanding deals are factored into an aggregate line irrespective
of whether the transaction is a buy or a sell.
- Net Line: outstanding deals are netted against each other where the buy-currency
is netted against the sell-currency per currency pair and represented as a base
currency
- Same-day Netting: outstanding deals are netted against each other where the buy-currency
is netted against the sell-currency per currency pair and where the deals mature
on the same value date.
Having the ability to choose from these options give you the ability to control
your credit risk exposure and at the same time remain nimble and competitive to
serve the client’s specific needs. These three models are applied to clients based
on their specific needs as well as counterparties and thus maximizing counterparty
forward facilities. Datasoft provides you with powerful tools to manage all foreign
exchange credit exposure risk.
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