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FORWARD CONTRACT

FORWARD CONTRACT. CONVENTIONAL PROCESS FOR FORWARD CONTRACT. Forward Exchange Cover (FEC) facility is available to Importers/Exporters to mitigate exchange risks on under Document Credits (DC) and Import/Export Contract (Cont)

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FORWARD CONTRACT

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  1. FORWARD CONTRACT

  2. CONVENTIONAL PROCESS FOR FORWARD CONTRACT • Forward Exchange Cover (FEC) facility is available to Importers/Exporters to mitigate exchange risks on under Document Credits (DC) and Import/Export Contract (Cont) • Importer/Exporter can enter into Forward Contract for sale/purchase of foreign currencies with the Bank at any time from the opening/registration of the DC/Cont subject that the period of the FEC should not exceed the validity of the DC/Cont

  3. REGULATIONS • FE cir 10/26.05.99):To prevent speculation by importers and exporters, Banks are instructed that in case of closing out of FEC with customers where underlying DC/Cont has been cancelled or has expired un-utilized, the spot rate for counter transaction would be lower/higher of those prevailing on the date of booking of the FEC and the date of close out. • FE cir 10/26.05.99):FEC for period less than one month is prohibited,FEC for one month will be for fixed maturity, in case payment is effected within one month this will be done applying Spot selling rate prevailing rate on the date of payment and the FEC will be closed out at the maturity date.

  4. Importer – Forward Contract for purchase of foreign currency • Day 1 Importer comes to MBL. He has to pay US$ 1 million on Day 90. Wants to book forward rate. • Prevailing Rate on Day 1 is 60. • MBL buys US$ 1million spot @ 60 • MBL enters into a spot sale: forward buy swap with another bank XYZ • XYZ Bank charges a Rs 1 premium • MBL adds its fee of Rs 0.10 and quotes a forward rate of 60+1+0.1 = 61.1. MBL enters into a forward sale contract with the client.

  5. Importer – Forward Contract for purchase of foreign currency CONTD. 7) On Day 90, Importer pays 61,100,000/- to MBL and gets US$ 1 million. 8) On Day 40, Importer indicates his inability to take the delivery and wishes to close out 9) MBL sells $ to client on Booking Rate i.e. @ 61.1 and buys it back at the lower of: 10) Prevailing Rate on Day 1 i.e. 60 Prevailing Rate on Day 40 say 61 11) Client will be charged 61.1-60 = 1.1 per $ i.e. 1,100,000 12)  In case the prevailing rate on Day 40 was 58, 13) The importer will be charged 61.1-58 = 3.1 per $ i.e. 3,100,000

  6. Exporter – Forward Contract for sale of foreign currency 1)Day 1 Exporter comes to MBL. He will receive US$ 1 million on Day 90. Wants to book forward rate. 2)Prevailing Rate on Day 1 is 60. 3)MBL sells US$ 1million spot @ 60 4)MBL enters into a spot buy: forward sale swap with another bank XYZ 5)XYZ Bank charges a Rs 1 premium 6)MBL adds its fee of Rs 0.10 and quotes a forward rate of 60-1-0.1 = 58.9

  7. Exporter – Forward Contract for sale of foreign currency CONTD. 7) On Day 90, Exporter receives 58,900,000/- and pays US$ 1 million to MBL. (7A)On Day 40, Exporter indicates his inability to give the delivery and wishes to close out 8)MBL buys $ from the exporter on Booking Rate i.e. @ 58.9 and sell it back at the higher of: (i) Prevailing Rate on Day 1 i.e. 60 (ii)Prevailing Rate on Day 40 say 59  9) Client will be charged 60-58.9 = 1.1 per $ i.e. 1,100,000 In case the prevailing rate on Day 40 was 62, the exporter will be charged 62.-58.9 = 3.1 per $ i.e. 3,100,000

  8. SHARIAH ALTERNATIVE FOR FORWARD CONTRACTImporter – Forward Contract for purchase of foreign currency Scenario 1: Complete Transaction maturing on Forward Delivery Date Day 1 Importer comes to MBL. He has to pay US$ 1M on Day 90 to his overseas supplier. Wants to book forward rate. • Prevailing Rate on Day 1 is 60. • MBL enters into an agreement to purchase w/ another bank XYZ US$ 1M on Day 90 say @ 61 • MBL adds its fee of Rs 0.10 and quotes a forward rate of 60+1+0.1 = 61.1 Rs/US$. MBL enters into an agreement with the client to sell $1 million on Day 90. • On Day 90, importer pays Rs 61.1M to MBL. • MBL keeps Rs 100,000 as its fee and pays Rs 61M to XYZ bank to receive US$ 1M. • MBL pays $1M to (or on behalf of) the importer

  9. Scenario 2: Incomplete Transaction – Closing Out between the Booking and Forward Delivery Date Prior to or on the delivery date, importer indicates his inability to take the delivery and wishes to close out the contract (eg. Day 40).  On Day 40 MBL will do the following: • Enter into a forward sale agreement (say @ Rs59/US$) with ABC bank to sell US$1M on Day 90 (to square its position with XYZ on Day 90).Client will be charged upfront, the difference in this forward rate and the Initial forward Rate for Day 90 (i.e. 61.1-59=Rs 2.1/US$)

  10. Scenario 2: Incomplete Transaction – Closing Out between the Booking and Forward Delivery DateCONTD. • Therefore in the above case if the spot rate on Day 40 is Rs 58/US$, according to this circular the client should have been charged (i.e. 61.1-58=Rs 3.1/US$). To keep in line with SBP’s requirement which is to prevent speculation, MBL will charge the same difference, however, the difference in Spot Rate for Day 40 and Forward sale rate for day 90 (i.e. Rs 59-Rs58 = Rs 1/US$ in this case) will be given to charity and will not be included in the gain/other income for bank • In addition, client will also be charged commission to execute this additional transaction. • On Day 90 MBL will receive US$1M from XYZ and will sell the same to ABC.

  11. Scenario 3: Transaction – Premature Delivery In case the Importer wants the delivery of US$1M on Day 80 instead of Day 90  On Day 80 MBL will do the following: 1) Buy US$1M from the market at spot rate (say @ Rs64/US$) 2) Settle the contract with the importer by selling US$1M for Rs 61.1 M as per the initial contract. 3) Enter into forward sale agreement with ABC bank (say @ Rs63/US$) 4) Charge the Importer upfront the difference (i.e. Rs 1/US$) 5) In addition, client will also be charged commission to execute this additional transaction. 6) On Day 90 MBL will receive US$1M from XYZ and will sell the same to ABC.

  12. RELATED ISSUES • The need to identify scheduled banks to advise them about our new format for the forward contract (our contract is not a sale/purchase contract rather an agreement to sell or purchase) • If the proposed Shariah alternative scheme is followed, it appears that MBL may not comply with SBP’s circular (FE cir 10/26.05.99). Do we need to get SBP approval?

  13. Exporter – Forward Contract of purchase foreign currency • Day 1 exporter comes to MBL. He will receive US$ 1 million on Day 90. Wants to book forward rate. • Prevailing Rate on Day 1 is 60. • MBL enters into an agreement to sell w/ another bank XYZ US$ 1million on Day90 say @ 59 • MBL subtract its fee of Rs 0.10 and quotes a forward rate of 60-1-0.1 = 58.9. MBL enters into an agreement to buy $1 million on Day 90. • On Day 90, client receives 58,900,000/- to MBL.

  14. Exporter – Forward Contract of purchase foreign currency CONTD. • MBL keeps 100,000 as its fee and receives Rs 59,000,000 from XYZ bank in consideration of US$ 1 million. • MBL pays Rs 58,900,000 to the exporter and gets US$ 1 million on Day 90 (7A) Prior to or on the delivery date, client indicates his inability to take the delivery and wishes to close out the contract. • MBL can only close out the contract on Day 90.

  15. Exporter – Forward Contract of purchase foreign currency CONTD. 9. Prevailing Rate on Day 90 is 64. 10. MBL charges 100,000 from client as its fee. MBL sells US$ 1 million to XYZ bank and receives 59,000,000. It buys $ on spot at 64 and loss 64,000,000-59,000,000 = 5,000,000 is charged to the client. . 11. Prevailing Rate on Day 90 is 58. 12. MBL charges the client 100,000 as its fee. It buys $ on spot at 58 and gains 59,000,000-58,000,000 = 1,000,000. This gain is forwarded to SBP.

  16. SBP APPROVAL The transformation commission of State Bank of Pakistan (with some other Shariah scholars) approved the following foreign currency forward cover transaction. We could do the same procedure for our Araboon/Hamish Jiddiyyah transaction of shares.

  17. CONCLUSIONS • Forward share transaction, should be through an agreement/undertaking to sell or purchase at a future date and it should not be a sale and purchase agreements. • An amount or part of the total price may be given by the bank to the other party (seller) in advance by way of earnest money (Araboon/HamishJiddiyyah)against the shares to be purchased at a future date. • If at the agreed time the party does not perform, the(seller) can recover the differential to compensate the loss suffered by him due to depreciation of the price and adjust the earnest money there against.

  18. Foreign Currency Forward Cover The Commission observed that forward foreign currency covers will be permissible subject to the following conditions: i)          The amount of foreign currency is needed for genuine trade or payment transactions. The need will have to be supported by appropriate documents so as to prevent forward cover for speculative purposes. ii)     The forward cover shall be through an agreement to sell or purchase and it shall not be a sale and purchase agreement. It means that sale/purchase shall take place simultaneously at the agreed time in future at the rate agreed upon initially at the time of agreement to sell or purchase.

  19. Foreign Currency Forward Cover CONTD. • While it will be permissible to fix the price of foreign currency in terms of Rupees according to the agreement, no forward cover fee shall be recovered. However, (i) an amount may be demanded by the bank from its client in advance by way of earnest money against foreign currency agreed to be sold at a future date or (ii) the fee could be built into the sale/purchase rate. • If at the agreed time the party does not perform, the bank can recover the differential and adjust the earnest money there against.

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