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How can pension funds get a better deal when it comes to FX?

FX good practices

Posted by MillTechFX

'3 min

21 November 2023

21 November 2023

For most pension funds, FX may not be a conscious investment choice. Many invest internationally to gain exposure to the diversification benefits inherent in other assets, meaning the currency exposure they get from investing in foreign markets is usually an unintended by-product of buying the asset.

In addition, pension funds that allocate to international external investment managers for both private and public market strategies can be subjected to capital calls in a foreign currency.

For example, a US pension fund might invest in a European private equity fund that can issue capital calls in EUR at various times over the deployment period of the fund. The pension fund must therefore convert USD into EUR in order to physically satisfy the capital call. Ensuring best execution for this kind of transaction is just as important as for a hedging transaction. 

When managing this currency risk, it is therefore important for pension funds to get the best possible conversion rate, or face potentially overpaying for their FX execution. Despite this, many pension funds may have traditionally paid too much for their FX transactions, whether in spot, forward or other products. 

An environment lacking transparency

One of the key reasons for this struggle is likely because of the nature of pension funds’ custodial relations. The single-party custodial format means that pension funds can feel as though they have little choice but to accept the FX rates offered to them by their custodian, often leaving them unsure whether they’re getting the best possible rate.

Pension funds, unwittingly, may therefore be significantly overpaying for their FX execution.

There is little recent research into pension funds overpaying, but reports that exist point in one direction. One study from 2010, for example, claimed pension funds may be paying more than 24 basis points above market rates per trade. Similarly, a paper published in the Financial Times argued that FX revenues for custodians are significantly greater than those of other banks and that the execution process lacks integrity or transparency. 

Despite efforts to increase transparency over the past decade, a pension fund’s ability to get the best possible rate is ultimately left down to the custodian. This means that it will, to a degree, always be left in the dark over whether it is accessing the best price.

Looking beyond the single-party custodial format

Fortunately, there is now an alternative to the status quo that enables best execution whilst reducing the operational burden traditionally associated with trying to achieve it. Technology has enabled new entrants to offer an alternative way to transact in FX that seeks to address the inequalities and opacity pension funds may currently experience.

The first step is for pension funds to access a greater pool of pricing:

  1. Multibank marketplaces offer pension funds access to multiple liquidity providers from a single interface. Rather than being offered one single rate like their existing set up, this enables them to see live rates of institutional grade quality on a single screen and to automatically execute at the best available rate. Having the ability to reach multiple counterparties is essential from a best execution perspective and can help ensure pension funds aren’t being overcharged. FX-as-a-Service delivers these multi-bank marketplace benefits whilst also streamlining onboarding and integration for pension funds.
  2. The next step is to get more transparency on pricing. The use of independent transaction cost analysis (TCA) exposes any hidden costs in the spread and enables pension funds to see exactly how much they are being charged for their execution.
  3. The final step is to provide all of these benefits from a single location which offers streamlined workflow, real-time reporting and TCA to demonstrate best execution. This has the potential to drastically reduce execution costs and operational burden. 

How MillTechFX can help

MillTechFX by Millennium Global is the FinTech affiliate of Millennium Global Investments, one of the largest specialist currency managers globally.

We provide access to a transparent marketplace for comparative FX execution from up to 15 counterparty banks, while harnessing a unique and significant pricing efficiency for our clients. Rather than having little choice but to accept the rates offered to them by their custodians, pension funds can automatically execute at the best available rate with the simple click of a button.

MillTechFX’s market access, pricing power and operational resource enable it to deliver a tech-enabled integrated solution that delivers transparency, cost reduction and operational burden reduction for pension funds.

Get in touch today to find out more.

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