Currency-linked investment products
Product features and key risks
In Hong Kong, currency-linked investments are a popular kind of investment product offered to retail investors. They are usually sold by banks as "currency-linked deposits". However, you should bear in mind that a currency-linked investment product is not equivalent to a time deposit and is not covered by the Deposit Protection Scheme in Hong Kong. Also, depending on the terms of the individual product, it may be not principal-protected.
A currency-linked investment product is a structured investment product that consists of a time deposit (in the deposit currency) with currency option (derivatives). In general, if you purchase a non-principal-protected currency-linked investment product, you will be selling a put option on an alternative currency (ie the linked currency) of your choice to the offeror (eg a bank).
Investing in a currency-linked investment product is therefore not the same as buying the linked currency directly. The proceeds that you will receive at the end of the tenor will depend on the exchange rate of the base currency (ie the deposit currency) and the linked currency.
Your return on a currency-linked investment product depends on whether the market exchange rate is at or above the predetermined conversion rate upon maturity.
Below is an example of a currency-linked deposit with the base currency in Hong Kong dollar and the linked currency in Australian dollar:
|Base currency||Hong Kong dollar (HKD)|
|Investment amount||HKD 60,000|
|Linked currency||Australian dollar (AUD)|
|Investment tenure (i.e. deposit tenure)||14 days|
|Conversion rate||6.9588 (AUD/HK)|
|Interest rate||16.5% per annum|
The scenarios below take into account the following assumptions:
- You expect the AUD to appreciate against HKD. But, if the linked currency moves in the opposite direction (ie AUD depreciates), you will receive the maturity proceeds (principal and interest) in AUD at the predetermined conversion rate on the maturity date.
- Early redemption of the currency-linked deposit is not allowed.
- In the calculation of interest, the number of days in a year based on which the annualiszed rate is computed varies. For example, for base currency in Pound Sterling (GBP), Hong Kong dollar (HKD) and Singapore Dollar (SGD), it is 365 days, and for other currencies it is 360 days.
- Upon maturity, assume the market exchange rate of AUD against HKD is 7.20000, which is above the predetermined conversion rate.
- You will receive the maturity proceeds in the base currency, HKD.
- Maturity cash amount received:
= Principal + Interest
= HKD 60,000 + [60,000X16.5% X (14/365)]
= HKD 60,000+ HKD 379.73
= HKD 60, 379.73
- Therefore, the return you will have is HKD 379.73.
- Upon maturity, assume the market exchange rate of AUD against HKD is 6.2300, which is below the predetermined conversion rate.
- You will receive the maturity proceeds in the linked currency, AUD, at the predetermined conversion rate.
- Maturity cash amount received:
= (Principal + Interest) converted at the predetermined conversion rate
= HKD60,379.73 / 6.9588
= AUD 8,676.74
- The maturity proceeds in AUD converted to HKD at the prevailing market exchange rate on the maturity date is:
= AUD 8,676.74 X 6.23
= HKD 54,056.09
Therefore, you will suffer a loss of HKD 5,943.91.
The above scenarios are provided for illustrative purposes only.
How does the product work?
In general, there is a minimum investment amount and a selection of available currencies offered by the offeror. For example, at the time you set up a currency-linked deposit with the bank, you choose a base currency, a linked currency and the deposit tenor. Based on your forecast of the foreign exchange movement of the linked currency that you choose, you will agree with the bank a conversion rate of the linked currency against the base currency (ie the predetermined conversion rate).
Upon maturity of the product, you will be paid the maturity proceeds which comprise the principal and interest in either the base or linked currency, depending on the prevailing market exchange rate compared with the predetermined conversion rate of the linked currency.
If the linked currency moves in the direction you expect, you will receive the maturity proceeds in the base currency. On the contrary, if it moves in the opposite direction, your maturity proceeds received will be converted to the linked currency at the predetermined conversion rate accordingly.
Key risks of currency-linked investment
Given that a currency-linked investment product is not equivalent to a time deposit and is often not principal protected, you should be aware that you could lose all your money in the worst scenario. Some common key risks specific to this investment product include:
- Not a time deposit
Currency-linked investment is an unlisted structured product embedded with derivatives. It is not equivalent to time deposit. It is also not protected under the Deposit Protection Scheme in Hong Kong.
- Derivative risk
Currency-linked investment is embedded with foreign currency option which involves risks, especially when selling an option. Although the premium received from selling an option is fixed, you may suffer a loss well in excess of such premium, and your loss could be substantial in extreme cases.
- Credit risk of the offeror
If the offeror of the currency-linked investment product becomes insolvent or defaults on its obligations, you will not receive any maturity payout on the maturity date. You may only claim as an unsecured creditor of the bank.
- Maximum loss
If the currency-linked investment product is not principal-protected, in the worst case, you could lose your entire investment if value of the linked currency payable by the offeror to you becomes valueless on the maturity date. Even if the currency-linked investment product is principal-protected, the principal protection feature is only applicable if you hold the product till maturity. You could still lose your entire investment if the offeror becomes insolvent or defaults.
- Limited maximum potential gain
The maximum potential gain is capped at the pre-determined interest amount on the currency-linked investment product.
- Market risk
The return of currency-linked investment depends on the exchange rate movement of the base currency against the linked currency. The exchange rate of a currency is affected by a number of unpredictable factors including macroeconomic and political factors. For example, the government of a country may impose exchange control or other monetary.
Measures with little or no warning, which may impact significantly on the convertibility and exchange rate of a currency against other currency.
- Currency risk
If the base currency and/or the linked currency is not your home currency, you will be exposed to currency risk when you convert the maturity proceeds back to your home currency. Also, if the base currency and/or linked currency is Renminbi (RMB) against a foreign currency, you should note that as RMB is not freely convertible and its value against other currencies fluctuates and will be affected by, amongst other things, the Chinese government' s foreign exchange policy, your return may be impacted adversely.
- Liquidity risk
Generally you cannot early terminate or adjust the transaction terms of a currency-linked investment product.
- No collaterals
A currency-linked investment product is usually not secured by any assets or collaterals.
Pre-investment cooling-off period
Pre-investment cooling off period (PICOP) is applicable to each particular deal of the currency-linked investment products if you are one of the following retail customer types:
- An elderly customer aged 65 or above, unless you are not a first-time buyer of currency-linked investment products and your asset concentration* is below 20% and you opt out from the PICOP arrangement; or
- A non-elderly customer who is a first- time buyer of currency-linked investment products and your asset concentration is 20% or above.
*The asset concentration refers to the percentage of total net worth (excluding real estate properties) to be invested in this product.
Under the PICOP arrangement, you should be given at least 2 calendar days (of which the last day should be a business day) to understand the currency-linked investment, consider the appropriateness of the investment and, if necessary, consult family members and friends. The terms of transaction will be fixed on the day when you give instruction to the bank to confirm a purchase, i.e. upon the end of the PICOP.
Choosing a currency-linked investment product
Currency-linked investment products issued by banks are not authoriszed by the Securities and Futures Commission but banks selling these products are required to comply with the requirements of the Hong Kong Monetary Authority (HKMA), the banks' regulator.
To enhance product disclosure to retail investors purchasing currency-linked investment products issued by banks, banks selling these products are required by the HKMA to distribute an Important Facts Statement (IFS) to the clients. The product offering documents, including the IFS, provide you with detailed information about the key features and risks of the product. You should read and understand the product offering documents before deciding whether to invest.
As always, you should not invest in any financial products you do not know or understand. Therefore, you should fully understand the features and risks of currency-linked investment products before deciding whether to invest. You are also advised to check out with the banks or seek independent professional advice if you are in any doubt about the product or whether it is suitable for you before making a commitment.