IOE Tradeportal

Close Out of Forward Contracts

It often happens that a company that has entered into a forward FX contract finds that it is impossible to meet its obligations on the original settlement date.

This can be due to a number of reasons. For example:

buyer may not pay the exporter on due date

buyer may not have allowed time for payment transmission
shipment of goods may have been delayed

contract may have been cancelled or reduced in value

transfer delays in the buyer's country

payment could be delayed in the banking system

Irrespective of the reason for non-receipt of funds, the obligations under the forward FX contract must be honoured.

EXAMPLE

A exporter has a contract under which he will receive US$10,000 in one month's time. His bank contracts to buy this amount forward for delivery in one month.

If the contract is cancelled or the expected payment will not be forthcoming for any reason, the exporter must instruct his bank to close out the Forward FX contract. This can be done at any time between the date of learning that payment will not be received and the settlement date of the Forward FX contract.

The date chosen to close out can depend on the exporter's view of the of the Spot Rate movement up to the original settlement date. However, for simplicity of explanation, we can chose to close out on the maturity date of the original forward FX contract.

To close out the FX contract the bank would sell to the exporter the missing $US10, 000 at the current Spot Rate. This is used to settle the original Forward FX contract and avoids the exporter being in default.

The bank then pays the exporter the outturn of the original FX deal. The difference between the cost of $US10, 000 at the current Spot Rate and the outturn from the original Forward FX contract is debited or credited to the exporter's account as the case may be.

The same process applies for importers buying currency to pay a supplier, except that the contract would be for the bank to sell the currency.