What happens to a forward contract if the sale is cancelled?

The contract stands. The business still has to deliver the currency on the agreed date, or settle the difference with the bank. In practice it can close the contract out at the current market rate, which crystallises a gain or a loss, or extend it to a later date if there is a genuine receipt to match. The bank will usually discuss it, but a cancelled order does not release the business from the contract.

Is over-hedging illegal?

Not in itself. It is a commercial and contractual problem: it can put a business in breach of a facility agreement that restricts hedging to real exposures, or outside its own treasury policy. Regulators have looked at it from the selling side: the UK Financial Services Authority listed it among poor sales practices in its review of interest rate hedges sold to small businesses. Rules on how banks sell these products differ across markets.

How can a business avoid over-hedging?

By sizing hedges to what is reasonably certain and adding to them as orders firm up, rather than hedging a full forecast at once. A written policy with a ceiling helps, as does comparing the book to actual orders regularly. Instruments with built-in flexibility, such as window forwards for uncertain dates or options for sales not yet won, reduce the problem at a cost. A swap can be set to step down with the loan's repayment schedule.

Can a swap be larger than the loan it hedges?

Yes, and it is one of the common ways over-hedging arises. A swap has its own notional amount and does not change when the loan does, so a partial prepayment, a faster repayment profile or a refinancing can leave it larger or longer than the debt. The excess then pays fixed and receives floating with no loan underneath. A borrower repaying early should ask for the swap to be reduced at the same time, and expect a break cost or receipt for doing so.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Over-Hedging: a Worked Example

When the sale goes and the contract stays.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-09 · 6 MIN READ

// THE SHORT ANSWER

Over-hedging is what is left when the exposure shrinks and the contract does not. A forward or swap states an amount and a date, and the sale or loan it was set against can change or go away, so the excess keeps gaining or losing on its own. A fire-engine body maker with US$6.75m of forwards against a contract book that has fallen to US$4.5m has US$2.25m it must still deliver, with no dollars coming in to meet it. A lender treats the excess as a position, because it can create a loss with nothing to offset it.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// MAKE THE CALL

Issue 02 — Aoraki Trade Exports. Paid in USD, costs in NZD, asking for a NZ$6m multi-currency facility. The MD won't say which currencies. Your call first, then the senior banker's.

Read the file →

PART OF Foreign Exchange Facilities

// 01 — HOW A GOOD HEDGE BECOMES TOO BIG

A hedge can be too large from the day it is sold. It can also become too large when the thing beneath it changes. An exporter sells forward against a forecast, and the forecast is missed. A business swaps a term loan, then repays part of it from a sale of assets. A tender is hedged before it is won and then lost. A customer's order is cancelled. The contract is a separate agreement and takes no notice.

Over-hedging can be a matter of amount or of time. A hedge that matches the loan today can run for five years against a loan with three left. The UK Financial Services Authority, reviewing interest rate hedges sold to small businesses, listed over-hedging among the poor sales practices it found, describing it as amounts or durations that did not match the underlying loans. That is a finding about one market and those products, but the arithmetic does not depend on where the loan is.

// 02 — HOW IT IS MEASURED

Cover = hedges in place ÷ remaining exposure

Over-hedged = hedges in place − remaining exposure (if positive)

Cash at risk = over-hedged amount × change in the rate

The exposure in the denominator has to be what is still expected, updated for actual orders, repayments and cancellations. A figure over 100% is the signal, read by currency and by maturity date: a book that is 80% covered overall can be 120% covered in one quarter and 40% in another. Timing mismatches are often temporary and fixable. A shortfall in the underlying business usually is not.

// 03 — THE EXAMPLE

A maker of fire-engine bodies, constructed for this page like every figure in it, has two overseas orders of US$4.5m, due for payment in nine months. It sells US$6.75m forward at 1.50 units of home currency, which is 75% of the US$9.0m expected. One buyer then cancels.

Expected receipts now: 4.50m

Forwards in place: 6.75m

Cover: 6.75 ÷ 4.50 = 150%

Over-hedged: 6.75 − 4.50 = 2.25m

Dollar up to 1.65: buy 2.25m at 1.65, deliver at 1.50

2.25m × (1.50 − 1.65) = (337,500) home currency

Dollar down to 1.35: buy 2.25m at 1.35, deliver at 1.50

2.25m × (1.50 − 1.35) = 337,500 home currency

The first US$4.5m of the forwards still does what it was meant to. The other US$2.25m is a bet on the dollar. It may win, as the last line shows, and that does not make it a hedge. The business took on a position it did not choose, of a size set by a customer's decision, and it must find the dollars at maturity or settle the difference in cash.

The same thing on the debt side: the business has swapped a US$10m loan at 4.50 fixed and repays US$4m early from a property sale. The swap stays at US$10m. On the excess US$4m, if the base rate falls to 3.00, it pays 1.50% with nothing to set against it, which is US$60,000 a year until the swap is reduced or expires. The figures are the example's.

// 04 — HOW IT DIFFERS FROM A HEDGE THAT LOST MONEY

The two get confused, and the difference matters. A forward that shows a loss because the currency moved in the exporter's favour is working: the loss on the contract is matched by a better rate on the sale. A swap with a negative value when rates have fallen is doing what was agreed, while the loan is costing less. Over-hedging is a different condition, in which there is nothing on the other side of the excess.

The accounts react too. Under IFRS 9, used in New Zealand and Australia in their local versions, once forecast cash flows in a cash flow hedge are no longer expected to occur, the amount held in the hedge reserve goes straight to profit or loss. HMRC's manual describes the same result for the UK frameworks. The hedge ratio is the measure a lender tracks to see this coming on a debt book.

DEFINED IN ONE PARAGRAPH → · HEDGE RATIO → · HEDGING POLICY →

// 05 — WHERE IT DECIDES A FILE

A bank sizes its derivative credit limit on the business's real exposures, so a book above those exposures is a limit used for the wrong thing. When the facts change, the desk's first question is whether the contract can be reduced, by closing out the excess at the current rate or rolling it to a real later receipt. Closing out turns an unrealised amount into cash, and until it is done the position stays open to the rate.

A facility agreement may prohibit speculative treasury transactions or limit hedging to actual or projected exposures, and where hedging liabilities share the lender's security, an excess position can take value that was meant to support the loan. Terms vary by agreement. A written policy with a ceiling, set before the rate moves, and a schedule reconciling the book to the order book each quarter, gives the lender early sight of a problem like this one.

HEDGE COVER → · WINDOW FORWARD → · FINANCIAL MANAGEMENT, READ BY A LENDER →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

Financial Services Authority, Interest rate hedging products: information about our work and findings, June 2012 — Lists over-hedging, where amounts or duration did not match the underlying loans, among the poor sales practices found in sales to small businesses — section 01.
HM Revenue & Customs, Corporate Finance Manual, CFM27210 (discontinuation of hedge accounting) — If a forecast transaction is no longer expected to occur, gains and losses deferred in equity must be taken to the income statement immediately — section 04.

// QUESTIONS PEOPLE ASK

What happens to a forward contract if the sale is cancelled?: The contract stands. The business still has to deliver the currency on the agreed date, or settle the difference with the bank. In practice it can close the contract out at the current market rate, which crystallises a gain or a loss, or extend it to a later date if there is a genuine receipt to match. The bank will usually discuss it, but a cancelled order does not release the business from the contract.
Is over-hedging illegal?: Not in itself. It is a commercial and contractual problem: it can put a business in breach of a facility agreement that restricts hedging to real exposures, or outside its own treasury policy. Regulators have looked at it from the selling side: the UK Financial Services Authority listed it among poor sales practices in its review of interest rate hedges sold to small businesses. Rules on how banks sell these products differ across markets.
How can a business avoid over-hedging?: By sizing hedges to what is reasonably certain and adding to them as orders firm up, rather than hedging a full forecast at once. A written policy with a ceiling helps, as does comparing the book to actual orders regularly. Instruments with built-in flexibility, such as window forwards for uncertain dates or options for sales not yet won, reduce the problem at a cost. A swap can be set to step down with the loan's repayment schedule.
Can a swap be larger than the loan it hedges?: Yes, and it is one of the common ways over-hedging arises. A swap has its own notional amount and does not change when the loan does, so a partial prepayment, a faster repayment profile or a refinancing can leave it larger or longer than the debt. The excess then pays fixed and receives floating with no loan underneath. A borrower repaying early should ask for the swap to be reduced at the same time, and expect a break cost or receipt for doing so.

// NEXT TO IT

// ON WHOSE DESK

The seats that read this term in an ordinary week. Each page says what the seat is for, who arrives in it, and the shape of the round it runs.

Markets salespersonSells the bank's markets products — foreign exchange, interest rate hedging, commodities — to corporate and institutional clients.
Treasury analystFunds the bank and manages the interest rate and liquidity risk created by its own balance sheet.
Corporate coverage bankerOwns the bank's relationship with a large corporate or institutional client and orchestrates everything the bank sells into it.

THE IN-TRAY · ONE MINUTE

Make the call on one file.

A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

THE CALL · THE LOAN · HEDGES

An importer with a floating-rate loan fears that rates will rise, and asks about an interest rate swap.

Before it signs, what does it most need to understand?

6 MORE ON THE LOAN · HEDGES →WHERE DO YOU READ FROM? THE PLACEMENT →

THE READING ROOMIN ONE PARAGRAPHOver-hedging What is over-hedging, and why does a bank watch for it?