TFEX USD futures an effective tool for FX hedging

A medium-sized contract is suitable for individuals and small and medium companies. This year, TFEX will enhance the usefulness of USD futures as a hedging instrument by collaborating with banks to form an extended service after the maturity of futures for investors who need to convert between dollars and baht physically. 

With cooperation among domestic regulators, the Bank of Thailand and the Securities and Exchange Commission, USD futures have been trading on TFEX since June 5, 2012. This contract allows one to buy or sell the dollar-baht exchange rate at a specified price and date in the future. 

The exchange rate has been able to trade freely according to the market mechanism of TFEX.  The trade is executed via TFEX brokers like other products in the exchange. 

Each contract nominates the standard transaction size at US$1,000. There are four contract terms, comprising the three nearest consecutive months and the next quarterly month. At the end of the maturity, the cash settlement will be applied to all opened contracts with the USD/THB rate, which is the same reference rate of the interbank transactions on that day. 

Those features are favourable to the operators of small and medium-size businesses, retail investors whose portfolios inherit currency exposure, and also regular individuals who plan to spend money abroad – either for buying assets or for their own education. With the diversity of investors in USD futures trading, at the end of last year, there were 396,138 contracts traded on the exchange. Those transactions during the first six months after the launch were equivalent to $396 million (Bt12.25 billion) in notional trade.

According to the liquidity provided by Krungthai Bank (KTB), the largest state-owned financial institution in Thailand and the market maker of these contracts, the price of USD futures has moved in line with the interbank rate, which is the wholesale price for a large transaction. Moreover, at the end of the contract, the final settlement for every open position will be marked to the market with the interbank USD/THB rate that is used prevailingly by financial institutes as a reference for the FX transaction. 

However, USD futures are cash-settled products. The final settlement process does not involve the FX physical delivery to either buyer or seller. Those entrepreneurs and individuals who would like to convert the currency have to go to banks to fulfil physical transactions. Unfortunately, the buy/sell rate at banks is for retail deals that are not relevant to the final settlement rate announced on the maturity of USD futures. 

To facilitate TFEX’s customers, KTB and the exchange set up a collaboration to connect USD futures with physical transactions at the bank. As a planned additional service, after the USD futures at TFEX reach maturity, clients will be able to make or take delivery of dollars at KTB with a small spread from the benchmark rate. 

With this physical alternative, USD futures will soon become prevalent as a hedging mechanism combining the futures and spot markets to help small and medium-sized businesses and individuals to lock in their exchange rates while also allowing access to the physical currencies. 

However, at the beginning, only Thai residents are allowed with conditions on time and the predetermined premium/discount rate from the final settlement price of the USD futures. For further information, contact TFEX through www.tfex.co.th or via e-mail: [email protected].

 

Kesara Manchusri is the Stock Exchange of Thailand’s executive vice president and head of the Markets Division.