It is common for companies operating across multiple jurisdictions to use different currencies for various purposes, such as making payments to local or international suppliers, receiving income from clients, undertaking direct investments, or receiving capital contributions from shareholders or parent companies, among others. Frequently, these activities entail the execution of foreign exchange transactions, generally involving financial institutions. In this context, such transactions carry greater risks than may initially appear, which it is advisable to understand.
This note provides a concise overview of the various types of foreign exchange transactions, their associated risks, and the information obligations imposed on entities offering such services when entering into these types of arrangements with their clients.
We have received multiple requests for legal advice from companies that, after entering into such transactions with specialised institutions, found themselves embroiled in disputes regarding the performance of the contract. In several of these cases, the financial institution sought to impose conditions associated with forward transactions which had not been duly explained or formalised in accordance with the requirements set out in the MiFID regulations, thereby giving rise to significant conflicts between the parties.
1. Types of foreign exchange transactions and their risks
There are, in essence, three types of foreign exchange transactions, distinguished by their settlement date (i.e. the date on which the exchange of currencies is actually effected):
- Spot Transactions. These are transactions in which settlement occurs at the time of entering into the contract or, at the latest, within two business days thereafter. This means that the currency purchased will be received at the agreed time, which cannot be later than two business days after the date of execution of the contract. The applicable exchange rate will be that which is agreed in the contract.
The principal risk in these transactions—as with all foreign exchange transactions—is that, by the time settlement occurs, the exchange rate may have fluctuated unfavourably, meaning that the agreed rate may be less advantageous than the prevailing market rate on the settlement date (i.e., the currency is being purchased at a higher cost than would otherwise be available). However, this risk is limited in comparison to other transaction types due to the short interval between the contract date and the settlement date, which reduces exposure to exchange rate volatility. In fact, in many instances, spot transactions are settled immediately upon execution of the contract.
- European Forward Transactions. These are transactions in which the parties agree in advance on an exchange rate to apply on a future date, on which settlement will occur. This settlement date cannot be unilaterally altered, except with the express consent of both parties (which would likely also entail an adjustment to the price).
Such transactions are frequently used as a hedging mechanism against exchange rate risk. This is because they enable parties to secure an exchange rate and avoid unfavourable market movements by the time settlement is due.
However, there is also the risk that exchange rates may move contrary to the client’s expectations, resulting in the obligation to purchase a currency at a higher exchange rate than could have been obtained on the market. Furthermore, in such cases, if the client ultimately decides not to proceed with the transaction, the financial institution may impose a penalty, typically calculated based on the exchange rate fluctuations between the contract date and the scheduled settlement date. It is therefore crucial to consider this possibility carefully before entering into a forward foreign exchange transaction.
- American Forward Transactions. These are similar to European forwards in that an exchange rate is agreed in advance for a future settlement date. However, in this case, the client is entitled to bring forward the settlement date unilaterally without affecting the agreed exchange rate.
The risks associated with this type of transaction are broadly like to those of European forwards. However, these risks may be mitigated by the client’s ability to anticipate settlement if they perceive that prevailing or anticipated trends in exchange rates may become unfavourable.
2. Obligations of financial institutions in relation to foreign exchange transactions
Entities entering into foreign exchange transactions with their clients are subject to various information obligations. These differ depending on whether the transaction is a spot transaction or a forward transaction (given that forward transactions typically entail greater risks and complexity, financial institutions’ obligations are more stringent in such cases):
- Spot transactions are not considered financial instruments, but rather payment services. As such, they are not subject to the pre-contractual information and investor profile assessment obligations set out in Royal Legislative Decree 4/2015 of 23 October, which approves the revised text of the Securities Market Act ( “TRLMV”).
Nevertheless, this does not exempt the service provider from certain information duties towards its clients. Specifically, the bank is required to provide, prior to the execution of the transaction, clear and sufficient information regarding the terms under which the service will be rendered, including its costs and the settlement date of the transaction. In other words, the financial institution must, in all cases, inform the client of the applicable exchange rate and the settlement date (which may be immediate or, at the latest, two business days following the date of contract execution).
- Forward transactions are, in most cases, considered financial instruments. As a result, their marketing is subject to enhanced information and investor assessment obligations under the MiFID regulatory framework.
In particular, institutions providing such services must comply with the MiFID requirements applicable to complex financial products, including: (i) the obligation to inform clients, well in advance of execution, of the product’s features and associated risks; (ii) the duty to keep clients informed regarding the performance of their products; and (iii) the obligation to assess the suitability and appropriateness of the product for the client, taking into account, among other factors, the client’s knowledge, experience, and risk tolerance.
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En Madrid, 20 May 2025.
¹Forward foreign exchange instruments shall not be considered financial instruments but rather means of payment when they meet the following conditions: (i) they must be physically settled; (ii) they are entered into by at least one party that is not classified as a financial counterparty; (iii) they are not traded on a trading venue; and (iv) they are executed for the purpose of facilitating the payment for identifiable goods, services, or direct investments. The last condition—often the most difficult to assess in practice—means that forward currency exchange transactions shall be deemed financial instruments where they do not relate to the client’s ordinary course of business or to a direct investment made by the client.
²Forward foreign exchange contracts that do not qualify as means of payment are classified by the CNMV as complex financial products, as they constitute derivative instruments linked to currencies.