What is FX risk?
Foreign exchange (FX) is the conversion of one currency into another. The rate at which someone can convert between currencies is known as the FX rate. Companies with employees, operations, or cash flows in multiple countries face FX risk: the possibility that the value of a future transaction in one currency is different than it is today.
An example
Let's take a U.S. company, Acme, with $6 million in monthly revenue and $5 million in employee expenses. In month 1, Acme earns $1 million in profit. Suppose Acme's employees are based in Mexico and paid in Mexican pesos (MXN). At the time of hiring, the USD/MXN exchange rate is 20 to 1: one dollar buys twenty pesos. Acme agrees to pay its employees 100 million pesos per month, equivalent to $5 million.
Let's flash forward to month 2: the dollar has depreciated and the USD/MXN rate has moved to 18 to 1. When payday arrives, Acme still owes its employees 100 million pesos. Those pesos now cost roughly $5.56 million. Nothing has changed in Acme's business, yet its profit has been cut by more than half, to $0.44 million. Now imagine Acme has employees on two continents, suppliers across seven countries, and customers paying in twenty-three different currencies, each with its own volatile rate. Welcome to running an international business.
The FX forward
Acme does not want its profit to decrease because of a movement in FX rates. To protect itself against this movement, Acme turns to the FX forward market. A forward is a contract that lets a company exchange one currency for another at a locked-in rate on a future date. In the example above, Acme can purchase a forward in month 1 that locks the cost of its 100 million pesos in month 2 at $5.0 million, protecting its full $1.0 million of profit, regardless of where the USD/MXN rate moves. Think of the forward as Acme's insurance policy against FX risk.
The FX forward market in 2026
To buy that insurance, Acme goes to a bank. Like an insurer, the bank has to assess Acme's risk before underwriting a policy. The forward commits Acme to transact at a set rate on a future date. The bank carries the risk that Acme fails to honor it. Will Acme be able to pay the $5.0 million it has committed to? If the dollar strengthens and those pesos can be bought for $4.5 million on the open market, will Acme still settle at the rate it locked?
Before Acme can purchase a forward, it must first become a customer of the bank. For Acme, that means months of credit checks, ISDA negotiations, and significant collateral requirements. To put several banks in competition for a better price, Acme repeats the entire process and posts collateral with each one, individually.
Even after clearing the bank onboarding process, the forwards a bank offers are limited. Contracts carry minimum trade sizes, often $2 million and up, fixed maturities, and T+2 settlement. If Acme has a $750,000 exposure due in four days, its bank is unlikely to offer a contract on those terms. Real business exposures rarely arrive in the predefined shapes a bank deals in.
Underneath it all sits decades-old infrastructure. Risk and back-office systems at major banks still run on interfaces built in the last century. Trades pass through chains of correspondent banks, each link adding credit, capital, and operational cost to the prices companies see.
The result is a fragmented, rigid, and expensive FX forward market.