Non-financial FX market shrinks, says Bank of England
The share of daily foreign exchange turnover held by non-financial corporates has fallen sharply as a result of the global financial crisis and derivative accounting rules, the Bank of England said in a report published on Monday.
Industrial and service companies that use the foreign-exchange market as part of their everyday business accounted for 13% of global FX market turnover in 2010, the bank said in its Quarterly Report, compared with 18% in 2007.
Non-financial companies focused on swaps to hedge underlying exposures, as well as forwards and the spot market, the BOE said. They made less use of options, which were employed by just 16% of large companies in the UK, and non-deliverable forwards. Cost was a major consideration for which instruments were selected. According to Euromoney market data, non-financial corporates make up 6% of total option turnover.
The average daily FX turnover of non-financial companies fell from more than $120 billion in October 2008 to around $60 billion later that year. It recovered by October last year to around $95 billion, the bank said.
“The potential benefits of hedging must be balanced against the costs of doing so,” the bank said. “For small companies in particular, the additional costs associated with hedging currency exposures may exceed the benefits of doing so.”
The decision to use foreign-exchange derivatives also depends on whether it is possible to use so-called hedge accounting rules. This is a complex set of rules under the international accounting standard IAS 39 that exempts certain transactions from mark-to-market obligations. Hedge accounting allows companies to delay recognizing gains or losses until the associated transaction is realized, lowering volatility in reported earnings.
The use of derivatives in jurisdictions where ‘fair value’ accounting applies may act as a deterrent because it means that mark-to-market gains or losses are recognized in the profit and loss statements of companies.
When asked about the significance of accounting considerations for hedging purposes, 33% of respondents to an April 2010 survey stated that accounting considerations were “critical”, 56% said they were “important” and only 10% said they were “unimportant”.
Shorter-dated hedging in maturities of less than one year was more popular than longer-dated hedging in the one-year to five-year area, because companies were reportedly more comfortable forecasting cash flows over the shorter horizon, the bank said.