Four key FX trends facing fund managers in Canada

Although volatility has decreased since peaking towards the end of 2022, it is still a persistent threat to fund managers in Canada due to a combination of rising interest rates, high global inflation and geopolitical uncertainty.

After making consistent gains against the greenback earlier this year, the Canadian dollar hit a six-month low in October 2023 only to then rebound slightly later in the month.

The US dollar itself has also fluctuated over the past year. Having reached a two-decade high against other major currencies in September 2022, it slid to a nine-month low in February 2023 and continued to dip until it rebounded again in September 2023.

This backdrop, in addition to the broader macro environment, could create uncertainty on returns for fund managers in Canada with exposure to foreign currencies. As a result, many are now reviewing their foreign exchange (FX) set up so that they can readily navigate this uncertain climate.

Here are four key FX trends that are likely to affect how Canadian fund managers manage their currency exposures over the next 12 months.

1. Changing face of FX hedging

 Our own CFO FX report found that 84% of fund managers in Canada have been impacted by US dollar volatility, whilst 98% said that FX was significant to their business.

Fund managers are subsequently renewing their focus on hedging, with 82% having a formal hedging program in place. Out of those that do not, half are considering implementing one.

Firms are adapting their hedging strategies to protect themselves against mounting uncertainty in the market. The average hedge ratio amongst Canadian fund managers was between 50-59%, with over eight out of ten citing this as higher compared to last year. This suggests that fund managers in Canada are moving to hedge more of their FX risk to protect their bottom lines from currency movements.

Likewise, rather than using long-dated FX forwards of up to a year or two, fund managers are opting for shorter hedge windows of six months or less, with the average hedge length at five months. This can help add an extra layer of flexibility and nimbleness, enabling them to adapt quickly should the market move against them.

Looking ahead, 51% of fund managers in Canada plan on shortening their hedge windows, whilst 53% plan on increasing their hedge ratio.

2. Counterparty diversification

 One of the biggest lessons for fund managers from the banking crisis earlier this year is the importance of having access to multiple counterparties.

For fund managers who trade FX for payment or hedging purposes, FX can be seen as second-order: they transact in FX not because they ‘want to’, but because they ‘have to’ due to international exposure. It is thus often operationally inefficient for them to set up and manage multi-bank relationships.

This means they are often reliant on one or two counterparties, and it can often take months to onboard others, which leaves them open to risk should another bank run occur. The loss of a major FX counterparty could render firms unable to trade, potentially impacting their ability to manage FX risk across their portfolios and share classes.

Our survey found that 82% of fund managers in Canada are looking to diversify their FX counterparties following the banking crisis earlier this year.

As well as enhancing risk management, having multiple counterparties can also have a positive impact on pricing. At any given time, fund managers may not be able to trade at the best available rate as they have no other access point to the market. Getting competitive quotes from multiple counterparties can enable fund managers to compare the market so they can ensure they get the best rate and achieve best execution. 

3. Automation drive

 For many fund managers in Canada, FX processes can be manual, cumbersome and time-consuming.

FX price discovery can often involve multiple phone calls, emails, or online platforms to log in to just to get comparative quotes from your counterparties. Because the market is constantly moving, price discovery often requires a team of people calling, emailing and logging in simultaneously before they can collectively decide who offered the best quote.

As a result, many are beginning to consider moving away from legacy infrastructure and instead embrace automated, tech-enabled solutions which digitise the FX process from initial price discovery right through to reporting at the end of the trade lifecycle.

Our research found that more than nine out of ten fund managers in Canada are looking into new technology and platforms to automate their FX operations.

The benefits of automated digital infrastructure include centralized price discovery, end-to-end workflow, enhanced transparency and faster onboarding.

4. Rising importance of ESG

 Environmental, Social and Governance (ESG) criteria have begun to play an increasingly important role in the FX industry. 89% of fund managers in Canada report that ESG has grown in importance to their business over the past year, whilst more than half (53%) believe that their FX counterparties must have strong ESG credentials.

When transacting in FX, fund managers can take the following steps to enhance their ESG credentials:

Adopting the Global FX Code (GFXC) - The BIS Foreign Exchange Working Group published this in 2017 to set out best practices across the wholesale FX market and is beginning to embed the code into firms’ ESG practices. Its members recently supported the possibility of a partnership with rating agencies so that anyone who signs the code can be recognised as having fulfilled the governance element of their ESG commitments. Signing up to the code is therefore a key step for fund managers seeking to demonstrate their ESG credentials.

Consider ESG credentials of partners - It’s not just a company’s own infrastructure that reflects strong ESG credentials but also that of any partner or affiliate organisation. When transacting in FX, we feel fund managers should seek to use FX providers which adhere to internationally recognised ESG standards, such as the Principles for Responsible Investment (PRI).

How MillTechFX can help

Looking ahead, we believe that FX risk management should be considered a top priority for fund managers in Canada and beyond.

MillTechFX by Millennium Global is the FinTech affiliate of Millennium Global Investments, one of the largest specialist currency managers globally. Our FX-as-a-Service model provides an end-to-end solution, from onboarding with up to 15 counterparty banks to execution, settlement and reporting of FX transactions, including TCA, across multiple funds.

Having recently become members of the Canadian Association of Alternative Strategies and Assets, we collaborate closely with fund managers in Canada to help them reduce their FX costs and the operational burden associated with FX execution and rolling hedge requirements.

To find out more about how we can help you navigate your FX challenges in 2023, get in touch with us here.

 

This data refers to a survey conducted by Censuswide on MillTechFX’s behalf in May 2023, based on a survey of 250 senior finance decision-makers, CFOs, treasurers and senior finance decision-makers at mid-sized asset management firms at North America-based (US and Canada) mid-sized fund managers.