Are you sure that equity futures don't have currency risk?

Yesterday, I heard someone say again that equity futures don't have currency exposure. While that is often the case, it is not always true and that is an important thing to keep in mind when analysing a portfolio or developing a portfolio analytics system.

The usual reasoning is as follows. Imagine I am a GBP-based investor who buys a future on the S&P 500 that is quoted in USD. Let's assume that the the futures price of an S&P futures contract is USD 1,000 with a contract multiplier of 1000. In essence, this position is equivalent to borrowing USD 1 million and buying USD 1 million worth of the S&P 500 index. So, my net exposure to the USD is zero. As a result, the value of my portfolio in GBP is not influenced by the GBP/USD exchange rate.

Or is it? There are two reasons why this may not be true for all equity futures:

a) Changes in the futures price
First of all, the futures price of an S&P 500 futures contract may change from the level at which I bought the futures contract. The most important cause of changes in the futures price is a change in the value of the underlying, but changes in the risk-free rate, yield, and time remaining until the contract date can also influence the futures price. In any case, let's assume that the futures price changes from USD 1,000 to USD 1,100.

So how does this change my USD exposure? Well, I still owe the USD 1 million I borrowed at the start of the contract, but I now have an exposure of USD 1.1 million to the index contract. Thus, my net exposure is USD 0.1 million. And if the GBP/USD exchange rate changes, then this will influence the value of my portfolio. That is, as soon as I have an unrealised gain or loss in the futures contract, I have a currency exposure.


In practise, most risk and performance systems will capture this currency risk. Most systems will evaluate the future as a short cash position of USD 1.1 mln. and a long equity position of USD 1.1 mln.. By itself, this would be incorrect: because I gained USD 0.1 million on the contract, the net value of the position should be equal to USD 0.1 million rather than zero. However, because futures are marked-to-market, I will have received USD 0.1 million on my margin account. As long as I add this USD 0.1 million cash position on my margin account to my positions in the risk/performance system, the system will see that I have a net USD exposure of USD 0.1 million and correctly measure risk and return.

b) Currency exposure in underlying
However, many risk and performance systems assume that, just because the future is priced in USD, that both the long and the short leg are 100% exposed to the USD. That does not need to be true, however. The cash leg (which is the short leg when I buy a future) will indeed have 100% exposure to the USD, but the equity leg may have non-USD exposure. This non-USD exposure can arise in four possible ways:

i. The underlying may contain securities that are denominated in a currency other than USD. An example is a future on the MSCI World index, which contains exposures to stocks that are listed in many different currencies.

ii. The underlying may contain depository receipts that, though they are denominated in USD, their actual currency exposure is to a currency other than USD. After all, a depository receipt is equivalent to a certain number of shares in a company on which the depository receipt is issued. For example, the Gazprom ADR that is listed on the NYSE and trades in USD will track the performance of the underlying Gazprom share that is listed on the RTS that trades in RUB. Just translating RUB to USD doesn't remove the RUB exposure.

iii. In some cases, futures trade in a currency other than the base currency of their underlying. For example, there are futures listed in Singapore that trade in USD but whose underlying is an Asian equity index. This clearly leads to substantial currency risk: we borrow in USD and commit to buy the underlying in a currency other than USD.

iv. More philosophically, we may question whether the currency of risk is always equal to the currency in which an instrument is traded. After all, the currency of risk is determined by the currency risk in the cash flows generated by the instrument and most companies have cash flows that are influenced by the currencies in which they trade their inputs and outputs and the degree to which they hedge the currency risk of these input and output prices. For example, Royal Dutch Shell shares may be listed in EUR, but it is likely that the cash flows of Royal Dutch Shell contain a lot of USD risk as the main output, oil, is traded in USD.

Clearly, therefore, equity futures can have currency risk. In many cases they don't, but don't assume that this is always the case. Are you sure your risk and performance system doesn't make this assumption?