When it comes to financial instruments, forward contracts are often used as a hedging tool to manage risks associated with fluctuations in prices of underlying assets. However, there is a debate around whether forward contracts qualify as securities, and in this article, we will explore both sides of the argument.
Firstly, let us define what is meant by a security. According to the U.S. Securities and Exchange Commission (SEC), a security is „any investment instrument, such as stocks, bonds, options, and futures, traded on a financial market.“
Forward contracts, on the other hand, are legally binding agreements between two parties to buy or sell a specific asset, such as a commodity or currency, at a predetermined price and date in the future. Unlike securities, forward contracts are customized to meet the needs of the parties involved and are not traded on an exchange.
Proponents of forward contracts not being securities argue that these contracts are private agreements between two parties that are not offered to the public. Moreover, forward contracts do not have an underlying security that can be traded on an exchange, unlike futures contracts.
However, the Securities Act of 1933 defines a security as any „investment contract,“ which means an agreement where investors put their money into a common enterprise with the expectation of profits solely through the efforts of others. When we apply this definition to forward contracts, it does appear that they have many characteristics in common with securities.
For instance, forward contracts can be seen as a form of investment since they involve buying or selling an asset at a future date for a specific price. Additionally, forward contracts are often used to speculate on the future price movements of an asset, with the expectation of making a profit.
Furthermore, forward contracts can be bought and sold in secondary markets, just like securities. While the market for forward contracts is not as transparent as that of the stock market, they are still traded among institutions and large corporations.
In conclusion, the question of whether forward contracts qualify as securities is not a straightforward one. While they may not be considered securities by some definitions, they do share many characteristics with them. Therefore, it is essential to consider the context in which forward contracts are being used before deciding whether they should be regulated as securities.