This article is provided by Alt21 Limited, trading as Alt21, an FCA authorised payments and FX provider and is intended for UK businesses considering FX hedging as part of their treasury activity. Any example or figure provided are illustrative only. FX hedging products carry risk, including the risk that rates move against you and that you may be asked to provide collateral at short notice, which could affect your cash flow. Comments from Pritesh Ruparel, Group Chief Executive Office (CEO) of Alt21 are contained within the article. As an Alt21 employee, his comments reflect his own experience working with Alt21’s clients and describe Alt21’s own products and approach, rather than independent market commentary. Hedging products and margin funding are subject to eligibility and are not suitable for every business. Please read the full disclaimer at the bottom of the page.
You can decide that protecting your business from an adverse currency movement makes sense and still face a very practical problem:
You have to pay for that protection.
Some FX options involve paying a premium upfront. For a business trying to protect its margins, that may be a perfectly reasonable cost.
But it is still cash leaving the business today.
For a growing company balancing payroll, suppliers, investment and working capital, that creates a trade-off. The hedge may fit the company’s objectives, while the timing of the premium doesn’t fit its cash flow.
So should paying for the hedge and deciding whether to hedge always have to happen at the same time?
Not necessarily.
Separating when the cost of protection is paid from the decision to hedge may help some businesses manage cash flow, although funding the premium adds a cost and creates an obligation to repay.
We’re speaking to Pritesh (Prit) Ruparel, CEO of Alt21, to learn more about the concept of hedge now, pay later, how it works, and what businesses may want to weigh up.
What does “hedge now, pay later” mean?
Hedge Now, Pay Later is Alt21’s approach to funding the premium on an FX option. Rather than requiring the full premium to be paid upfront, Alt21 may allow an eligible business to repay it in instalments over an agreed period.
This is a form of credit; it carries a funding cost in addition to the premium, and it is subject to credit assessment.
Prit describes it as a form of B2B credit: financing for the option premium. Margin requirements are separate from the premium funding, and depending on the contract, you may be required to provide additional margin.
The basic idea behind hedge now, pay later is this:
The business can put its chosen protection in place without necessarily taking the entire premium from its cash balance immediately, but it remains liable for the full premium and a funding cost, and must make the agreed repayments.
But the important part isn’t simply delaying payment because funding has a cost too.
If the funding cost isn’t shown separately from the FX price, a business may struggle to understand what it’s actually paying for the hedge and the funding.
Make those costs visible separately, and the finance team can make its own comparison.
For one business, paying the premium upfront may make the most sense. Another may decide that keeping cash available elsewhere in the business is worth paying for funding.
Neither decision is automatically better, but the approach helps you see the economics of both.
| Important information/risk warning:
FX options involve paying a non-refundable premium. If the option isn’t used, the premium is lost. Options are complex instruments and are not suitable for every business. Where the premium is funded through margin funding, the business is committed to the agreed repayments and funding cost regardless of how the market moves, whether the option is used, or whether the underlying exposure changes. Margin funding is subject to eligibility and credit assessment. FX options are over-the-counter contracts and carry counterparty risk. |
Why do some FX hedges have an upfront premium?
An FX option gives a business the right, but not the obligation, to exchange currency at an agreed rate within specified terms.
A forward contract commits both parties to exchange currencies at the agreed rate, even if the market later moves in the business’s favour. It does not usually involve an upfront premium.
An option can provide protection against an adverse movement while allowing the business to benefit from a favourable one, but only after the premium has been paid, and the premium is not refundable.
But that flexibility has a price:
The option premium. It’s non-refundable, whether or not the option is used.
Prit compares it with insurance:
“You’re paying for that protection. Sort of like an insurance product. You’re paying to protect your margins upfront.”
An option isn’t an insurance policy, but the comparison holds in one respect: the premium is paid whether or not the protection is ever needed.
The premium reflects factors such as the rate, the term and market volatility, as well as Alt21’s mark-up.
If the market moves against the business, the option can provide protection within its agreed terms. If the market moves favourably, the business can still potentially benefit from that movement.
That second part can sometimes get lost when businesses look at the premium simply as a cost.
As Prit puts it:
“You still get the benefit of the upside, which is a big thing that often gets ignored.”
That benefit is always net of the premium already paid. If the favourable move is smaller than the premium, the business may still be worse off overall.
You may be interested in reading our guide on forward contracts vs FX options.
The cash-flow trade-off of paying an FX premium upfront
The difficulty is that an upfront premium has an immediate effect on cash flow. If you’re a growing business, balancing investment, payroll, suppliers, and other commitments can create an additional cash flow decision.
A company can generate significant revenue while still having periods when its available cash falls as it pays suppliers, invests in growth, hires people or meets other commitments.
Adding an option premium to those outgoings can make a hedge that fits the business’s objectives commercially difficult.
Prit explains:
“They’d rather spend the money on growing a business, growing a team, maybe having some reserves in case of a bad day or a bad month.”
That doesn’t necessarily mean the business cannot afford to hedge, but there’s an opportunity cost attached to using its cash to pay the premium upfront, which is a slightly different problem.
Imagine the premium for an FX option is £10,000.
The business has enough cash to pay it.
But it also needs that cash to purchase stock. If it uses the £10,000 for the option premium, it may need to use an overdraft or another form of borrowing to meet its other commitments.
Suddenly the finance team has two costs to consider:
- The cost of the option itself.
- The potential cost of using the company’s cash to pay for it.
Prit gives a similar example. If a company’s alternative source of borrowing costs 8%, using its own cash for the premium and borrowing elsewhere could have different economics from financing the premium itself. The answer will depend on the individual business and the terms available to it.
Affordability remains important, including whether you could meet the repayments if the premium is funded.
A better comparison might also be what it costs us to use our cash here, and what it would cost us to keep that cash in the business.
What if your cash flow isn’t consistent throughout the year?
Businesses don’t necessarily generate or spend cash in neat monthly instalments.
A seasonal business might have periods of significantly higher or lower cash availability. A large supplier payment may fall in one month. Revenue might arrive unevenly throughout the year.
Which raises the question:
If the underlying FX contract can be structured around a business’s requirements, should the way the premium is funded be able to reflect those requirements too?
Prit explains that these are over-the-counter contracts, meaning payment arrangements can potentially be structured around the circumstances of the business rather than always following identical instalments.
Alt21 may, for some eligible businesses, agree a repayment schedule that reflects expected cash flow. Availability depends on credit assessment, and later repayments may increase the total funding cost.
Over-the-counter contracts are agreed directly between the business and Alt21 rather than traded on an exchange, which also means the business is exposed to Alt21 as its counterparty.
He gives the example of a company knowing that February will be particularly tight but expecting greater cash availability in March or April. Rather than treating the payment schedule as completely fixed, there may be scope to structure it accordingly.
The exact terms and availability will depend on the arrangement and the business.
But the principle is useful – A financial product designed to help manage uncertainty shouldn’t unnecessarily create a new cash-flow problem of its own.
Funding doesn’t remove the cost; it changes when it’s paid and adds a funding cost of its own. Where available, the repayment schedule may be arranged to reflect the business’s circumstances.
What happens if the underlying exposure changes?
Forecasts change, and with it goods can arrive later than expected; payment dates may move, and the timing or size of your exposure can change after a hedge has been put in place.
Which is where the premium comes in. Was it funded or paid upfront?
If the premium was funded, the business still owes the remaining payments, including the funding cost, even if the exposure falls away or the option expires unused.
Prit explains:
“Business doesn’t always go to plan. Timings change, payments move, and the exposure you originally hedged may look different. You may be able to amend or close out the contract before expiry, but that won’t always be possible, and there may be a cost.”
This is why FX hedging shouldn’t be treated as something you set once and forget entirely. The hedge still needs to relate to the underlying business exposure, and if that exposure changes, the business needs to understand what that means for the hedge and any costs associated with it.
With that said, there’s a broader principle underneath all of this:
Businesses need enough information to compare their choices.
If credit is bundled into an FX price, it can be difficult to tell how much the business is paying for the hedge itself and how much it is paying for the financing around it.
Separate those costs and the decision becomes much clearer, to the point where a finance team with plenty of available cash might look at the funding cost and decide:
We don’t need this. We’ll pay the premium ourselves.
Another might decide:
Keeping that cash available for the business is worth the additional funding cost.
That’s exactly the choice Prit wants businesses to be able to make with “hedge now, pay later.”
As he explains:
“At least they have the information to make a decision, rather than having credit built into the price without seeing it.”
That principle extends beyond option premiums. Credit isn’t free simply because its cost isn’t presented as a separate line item. And removing an upfront payment doesn’t necessarily remove risk from a financial product.
Understanding what you’re paying, what risk you’re taking and what alternative you’re giving up makes it much easier to decide whether the overall arrangement fits your business.
You may be interested in our guide on exchange rate management.
What should you consider alongside FX hedging costs?
The most interesting part of this conversation isn’t really how you pay an option premium.
It’s why you were considering the hedge in the first place.
Businesses can easily get pulled towards trying to answer questions about the market.
Will sterling strengthen?
Will the euro fall?
Should we wait another week?
But those aren’t the questions that make hedging part of a repeatable financial process.
Prit sees the shift happen when a business starts from its own numbers instead:
“For some customers, the starting point isn’t what the market might do next. It’s their own margins, their cash flow and what they want to protect. From there, hedging can become part of the wider treasury process.”
There is a cost to doing that.
Sometimes it’s an option premium, or there may be a funding cost. Other approaches, such as forward contracts, commit you to exchange currency at the agreed rate even if the market moves in your favour, and may require margin.
Hedging does not guarantee a better outcome. If the market moves in your favour, you may be worse off than if you had not hedged, and an option’s premium is lost if it is not exercised.
The job of the finance team is to understand them, the exposure you’re managing, the protection you’re getting, what you’re paying for it and what using that cash elsewhere would mean for the business.
Once those things are visible, you can make a more informed decision, including whether you could meet any funded repayments.
Manage your currency exposure with greater visibility
Alt21 gives finance teams the tools to manage currency exposure alongside their wider multi-currency finances, with pricing, including any funding cost, shown before they commit.
Speak to our team about your currency exposure and the approaches available to your business.
Alt21 Limited is authorised and regulated by the Financial Conduct Authority (FRN: 783837) and is a company registered in England and Wales (number 10723112). The registered address is 45 Eagle Street, London WC1R 4FS, United Kingdom. This article has been produced by Alt21 Limited for information purposes only. It does not constitute financial advice or an offer to sell or the solicitation of an offer to buy any products referenced. Hedging products are not suitable for every business. Margin funding is subject to eligibility and credit assessment, and creates an obligation to make the agreed repayments, including any funding cost, regardless of market movements or whether the option is used. Before entering into any FX product, you should consider whether it is appropriate for your needs and circumstances. Alt21 Limited assumes no liability for errors, inaccuracies or omissions. Eligibility criteria and terms and conditions apply to all products and services offered by Alt21 Limited. Not all applications will be accepted.
