Hunt on for new currency solutions in uncertain world

The notoriety of derivatives during the financial crisis is no deterrent for corporate clients eager to explore new foreign exchange solutions in a more uncertain world.

The appeal of ‘judicious derivatives’ has been showcased by Imara SP Reid, the Johannesburg-based stockbroker that has long offered a derivative trading platform and is close to client sentiment on geared instruments to manage currency risk.

“For some, derivatives are tainted by association with toxic bank assets and the speculative wave that culminated in last year’s financial crisis,” says Guy Algeo, a director of Imara SP Reid.

“But there’s little anti-derivative prejudice among defensively minded clients whose most worrying exposure is potential rand weakness in volatile markets. They want flexible, cost-effective solutions and are not put off by an unfortunate reputation acquired in a totally different scenario.

“Clients remain cautious, however, and demand transparency so they can track market movements and exposure. This explains the growing appeal of Yield-X.”

This is a regulated exchange for trading currency futures – a contract between buyer and seller quoting a rand price at a future date. The exchange currently offers currency futures giving rand prices against the US and Australian dollars, euro and sterling.

Traders take long (buy) or short (sell) positions. Gearing occurs as a relatively small ‘margin amount’ is placed against a much larger exposure. Pricing is transparent on the exchange throughout the day. A registered member of the exchange like Imara SP Reid may even offer a 24-hour tracking service across international time zones.

Imara SP Reid was founded in 1938 and maintained a robust derivative trading desk during recent market volatility when geared products experienced heavy ‘stress testing’.

“Heritage and long-term credibility give us an advantage,” says Algeo. “A service is unlikely to be dismissed as a gimmick when you’ve retained clients for decades. If we see a role for these instruments, a client will at least spend time examining the mechanism.

“Gearing magnifies losses as well as gains, so caution is indicated. You also need a clear understanding of what a futures contract does for you and how it fits your broader strategy.

“The role of currency futures is relatively easy to explain to importers and exporters, especially as many are already in the market for cost-effective alternatives to forward contracts.”

Forward cover is sold by banks for a fixed fee while the cost of currency futures has reduced steadily since Yield-X was opened up to corporates and institutional traders in 2008.

“Currency futures not only provide a cost-effective rand hedge, if the market moves in your favour you can also profit from the transaction,” says Algeo. “You get what you pay for – volatility protection – with perhaps a bonus on top.

“You manage currency risk without using a foreign exchange allowance or being restricted by exchange controls. Smaller companies see benefit in reduced paperwork as they are spared reserve bank processes. You also access favourable rates usually reserved for big corporates.

“As South African companies re-enter world markets after recent shocks to the international system, futures contracts will perform an important role by controlling risk at competitive prices with less red tape.”