Forex Investment and Currency Trading

A Cross Currency Swap, or CCS, is an agreement between two parties to exchange both principal and interest cash flows denominated in different currencies. In its most common form, the Cross Currency Swap is based on floating rate flows in one (non-USD) currency against floating rate (i.e. LIBOR) payments in USD, but many other structures and currencies are possible. Usually, the principal amounts in each currency are exchanged at the start and end of the transaction.

Cross Currency Swap are typically used to take advantage of advantageous borrowing opportunities in different credit markets, particularly where a borrower faces differences in funding costs or credit pricing across markets. A borrower or bond issuer can use a Cross Currency Swap to help diversify their investor base or to lower their cost of funds. From a portfolio management or investor point of view, a Cross Currency Swap can be used to diversify currency exposure.

For example, ABC Corp accesses the USD loan market and swaps its borrowing into CAD, its domestic currency. ABC Corp thereby hedges the principal and interest payments under its USD loan.

A key issue is matching the tenor of the swap, the underlying borrowing, and the use of funds – otherwise ABC Corp will be unduly exposed and unwind costs may be incurred if a subsequent asset/liability mismatch requires early termination.

The economics of the product are driven by the “Basis Swap” market, i.e. the relative attractiveness of borrowing or lending in one currency vs another.

The interest rates on a Cross Currency Swap are often floating for both legs (sometimes this is specifically referred to as a “Basis Swap”). A common variation is where one (or both) of the interest rates legs are fixed: this is something referred to as a Fixed/Floating Cross Currency Swap.

In some emerging markets, the convention is for the emerging market currency leg to be quoted as a fixed rate against USD LIBOR. This is usually due to liquidity issues arising from the absence of a widely acceptable floating rate benchmark in some emerging markets.

As with vanilla swaps, various additional features can be embedded in Cross Currency Swaps, including in-arrears, Quanto and accreting/amortising notionals.

In many markets, Cross Currency Swaps can be quoted on a non-deliverable basis so that all payments are net settled in USD and there are no cash flows in the non-USD currency. This can help non-domestic counterparties to manage their payment flows.