Noticed the Exposure. What Happens Next

A company usually decides to hedge before it can say precisely what it is hedging. The trigger is qualitative. A second and third currency become material, floating debt grows past the point where a rate move is absorbed in the margin, a board asks a question nobody can answer to the nearest million. The exposure is not new. What changes is that it becomes visible.

What follows is mostly not the hedging, and the pricing sits near the end of it. This post walks through the six steps between the decision and the first trade: sizing the exposure, deciding what it is protecting, choosing the instrument, the paperwork, the benchmark and the execution. Then it covers the places where first programmes usually stall.

1. Quantify the exposure

Deciding what is material needs forward curves in every currency of exposure, and a profile of how that exposure runs off over time rather than a snapshot of today.

Rate exposure is the easier of the two to size. The notional is the drawn balance, the profile follows the amortisation schedule, and the dates sit in the facility agreement. It is known rather than forecast.

Currency exposure rarely arrives that neatly. Revenues and costs are forecasts, the amounts move with volumes and the timing slips. Sizing it means judging how far out the forecast is reliable enough to hedge against, and that judgement sets the tenor of the whole programme.

The useful output is not a single number but a short table: each exposure, its size, its direction and how certain it is. Companies often find two of five currencies carry almost all the risk, and that is cheaper to discover in advance than live on a call with a bank.

2. Decide what you are protecting

A hedge is not a view on rates. Name the thing being defended, whether a budget rate, covenant headroom or a margin, and the ratio and tenor follow from it.

On rates the ratio is often not a free choice. Term loan facilities frequently carry a hedging covenant setting a minimum proportion of the drawn balance to be fixed, a window to have it in place by, and sometimes a maximum so the borrower cannot overhedge. Read it closely. What counts toward the ratio, and what happens if a prepayment pushes the hedge above the limit, are negotiated points rather than standard ones.

Currency carries no equivalent constraint, so the FX ratio is a genuine policy decision. The usual shape is layered: more of the near months where the forecast is firm, less further out.

3. Choose the instrument, and let security decide what is available

Swaps fix a floating rate for the life of the debt. FX forwards fix a rate for a cashflow on a known date. Neither costs anything upfront, and both bind in each direction. If the market moves in your favour you do not get the benefit, and the contract itself takes on a value, positive or negative to you, which is what gets settled if you exit early. That value is the mark-to-market.

Caps cost a premium paid at the start and protect against rates rising above a chosen level, the strike, while leaving the benefit if rates fall. Swaptions buy the right, but not the obligation, to enter a swap on a future date.

Two things decide between them.

Whether the exposure is certain. Drawn term debt and contracted receivables suit the binding instruments. Debt that may be repaid early, or a revenue forecast that may not materialise, suits paying for the right to walk away, because a swap or forward against a cashflow that never arrives stops being a hedge and becomes a bet on the market. The difference shows up on exit. A cap can only ever be sold back for cash and can never cost anything, while a swap unwound when its mark-to-market is negative means writing a cheque. Where the exposure depends on a transaction that has not yet closed, deal-contingent hedging is priced and documented differently again.

What security is available. A swap or forward creates credit exposure for the bank for the whole life of the trade, and the bank prices that according to what protects it. Where the hedge can rank inside the existing security package alongside the lenders, a swap works and prices well, because the credit charge inside the rate falls materially against the unsecured equivalent. Where it cannot, or where daily collateral calls would create the liquidity problem the hedge was meant to prevent, a premium-paid cap or swaption is usually the answer. The cost is settled at the outset, so there is nothing left to secure and nothing to post.

In project finance the security question is the whole process. Debt funds, insurers and pension lenders write project loans but do not run derivatives desks, so the institution providing the hedge is increasingly not the institution providing the debt, while the facility agreement still mandates the hedge. A third-party provider has to accede to the security package and take its place in the payment waterfall before its desk can price anything, because a bank cannot put a credit charge on a fifteen-year swap without knowing whether it will be secured. Ask for a quote before that point is settled and you will get a wide indication padded for the uncertainty, or a number that is withdrawn once the answer arrives. The consent points, the counterparty list and the credit pack are a process of their own, and we cover it end to end in running a standalone swap process.

4. Start the paperwork early

The documents are an ISDA Master Agreement and Schedule, which is the standard contract every bank trades derivatives under, plus a Credit Support Annex if collateral is going to move. Alongside them sit onboarding, KYC, entity classification and a Legal Entity Identifier, required before the first trade. Across several banks this runs to weeks, and started at the point of execution it becomes the reason the hedge is late.

Being an existing borrower of a bank does not mean being onboarded to trade derivatives with it. Know-your-customer is broadly common, but lending onboarding and derivatives onboarding run through different teams against different rulebooks, and completing one does not advance the other.

Two of these regularly surprise companies hedging for the first time. Client categorisation is not automatic: a small or newly incorporated entity may not meet the quantitative tests for professional status, in which case the bank runs a qualitative assessment that can extend to evidence of the directors' experience with derivatives. And the LEI has to exist and be current before a trade can be reported. A lapsed LEI on a quiet subsidiary is a common late discovery.

None of the documentation is a filing exercise either. The terms that matter commercially are argued over: when a bank may terminate early, what happens to the hedge if the loan is refinanced, how much headroom there is around the required ratio. Each is a right the bank either holds or does not, and each has a price. Where hedge providers share the lending security, those points are settled in the facility documents and the ISDA implements what was already agreed. Settle them before the trade is priced, because a bank that already holds an early termination right has little reason to give it up afterwards.

Collateral is where secured hedges differ most from corporate ones. A corporate hedge typically comes with a Credit Support Annex and daily cash margining. Where the hedge is secured on the same assets as the debt, a CSA is often unnecessary, because the credit support is the asset package rather than posted cash. Our ISDA and CSA negotiation guide covers the Schedule provisions in detail, including the borrower-friendly positions.

The hedge accounting treatment is worth settling with the auditors while the documentation is still in draft. Designation has to be documented at inception, so it cannot be tidied up once the trade is on the books.

5. Get the mid before you call

A quoted hedge price is not a single number. It is the underlying market rate, known as the mid, plus a credit charge, a funding charge and a capital charge, none of which is visible in the all-in figure the bank gives you. The gap between the quote and the mid is the sum of those charges, and once it is a specific figure it becomes something to discuss rather than accept.

On longer tenors the cash value of that gap is larger than it looks. A basis point on a fifteen-year swap is worth roughly eleven to thirteen times a basis point on a one-year, depending on the rate level, because the difference is paid on every payment date for the life of the trade. Converting the gap into present value, rather than leaving it in basis points, is what makes it legible to a board.

Comparison also only works if the instrument is identical on both sides. Frequency, day counts, business day convention, calendars, roll dates, the notional schedule and the floating index all have to be pinned down before anyone quotes. BlueGamma exports a term sheet directly from a priced interest rate swap, so the banks work from the same schedule that was priced. The same discipline applies on an FX programme, with value dates and amounts fixed and circulated before anyone quotes.

Two further habits keep the quotes honest. Ask each bank to quote in three parts, the mid plus the execution charge plus the credit charge, adding to the all-in rate: that format makes the charge visible without anyone having to argue about it, and it makes the quotes comparable with each other, which an all-in rate on its own never is. And give every bank a pricing date and a response deadline, so quotes arrive inside one window rather than across several days on a moving curve. Where a bank's mid differs from an independently calculated one, that is usually a conventions difference to resolve before comparing anything else.

6. Execute, then record the mid

With identical terms and a common window, the decision on the day is usually price. The quote is live and executable for a short window, often minutes, because the underlying curve moves continuously. That is why the calculation gets run on the agreed parameters in the weeks before, so the gap between the mid and any quote is understood before the day rather than during it.

Record the mid at the moment of execution alongside the traded rate. That record is what makes the next round of quotes easier, and what turns a first hedge into a programme rather than a one-off transaction.

The confirmation arrives within a few business days and restates the economics. Check it against the term sheet and the loan: fixed rate, effective and maturity dates, the full notional schedule, day count on each leg, payment dates, business day convention and calendars, and the floating index and tenor. The error that matters most is a date mismatch between the hedge and the loan, because payment dates that drift from the facility's interest periods stop offsetting cleanly and make any hedge accounting relationship harder to support. Fixing a confirmation in the first week is administrative. Fixing it in year three means a restructure or a breakage calculation.

Where first programmes stall

The long stages sit at the front of the process, and none of them is pricing.

The recurring failure is sequencing rather than effort. Derivatives onboarding is assumed to be covered by the lending relationship and starts weeks after it should. The security question is raised after quotes have already been requested, and the indications have to be redone. The notional schedule changes after the ISDA has been drafted. The conventions are never agreed explicitly, so the quotes that come back are comparable neither with each other nor with any benchmark.

And the workstream never acquires its own momentum. Onboarding and ISDA negotiation run on their own clock, staffed by teams with no sight of the deadline unless somebody gives it to them. Telling the onboarding team the target date at first contact, and asking them to confirm they can execute on it, costs nothing and removes the most common cause of a late hedge.

Started at the point someone first asks for a quote, a programme is already most of those weeks behind. Our note on five ways hedging can go wrong covers the errors that persist after the trade is on the books.

Starting small is not a compromise

A first programme does not need to cover every exposure. Hedge the largest and most certain exposure first, run the sequence once end to end, and extend having seen where the friction actually is.

Frequently asked

How long does it take to go from decision to first trade? Where documentation is in place, days. Where it is not, six to twelve weeks, and the constraint is onboarding and legal rather than pricing.

Is it necessary to hedge everything? No. Most programmes find the exposure concentrated in a small number of currencies and tenors, which is what step one is for.

Can a company hedge without posting collateral? Yes, either through a secured structure where the hedge ranks with existing lenders, or through premium-paid caps and swaptions where the cost is settled at the outset.

Running the sequence in-house

Whatever route a company takes to a counterparty, the arithmetic at the end is the same: the quote, less an independent mid, is the charge. BlueGamma produces the second number: forward curves across 30+ currencies, FX forwards and a swap pricer that handles amortising and sculpted notional schedules, in the web app, in Excel and via API. Priced swaps export straight to a term sheet in the web app.

If you are starting a hedging programme, you can try it free for 14 days, no card required, or book a call with our team.