The Benefits of No-Margin Hedging

Institutional investors often face significant currency risk exposure due to overseas investors committing to their funds or growing their portfolio in foreign markets. Fluctuations in exchange rates can affect their investment returns, which can lead to significant financial losses. In order to manage these risks, many fund managers turn to FX hedging strategies to mitigate currency risk exposure by providing protection against unfavourable currency fluctuations.

This means that fund managers can better manage their investment risks and achieve more stable returns.

In addition, by hedging their currency risk exposure, fund managers can focus on their core investment strategies, rather than worrying about currency fluctuations.

The ability to hedge foreign exchange risk without having to post collateral in the form of initial margin or variation margin offers numerous benefits to almost any type of investor.

Reduced Cost

If you’re a fund manager who hedges FX risk using products such as swaps, forwards or non-deliverable forwards, then you may have experienced first-hand a hidden cost of hedging that isn’t often spoken about. It’s not hidden execution spreads, service fees, forward points or even payment fees – the hidden cost is the cash drag associated with placing margin. 

If a funds’ expected returns are 8%, then an investment of $100m should yield $108m. If 10% of investible capital is held back for margin or contingent liquidity, then the remaining $90m must generate a return of 20% to get to the same figure! 

Without an unmargined FX facility, a fund manager must deposit collateral in order to enter into an FX hedge. This can be a significant amount, especially for larger trades.

Investor capital does not come cheap and if a fund manager isn’t fully invested, then deployed capital must work even harder to hit the target returns of drawn capital.

No margin hedging allows fund managers to remain fully invested while mitigating their FX risk.

Lower Risk

If FX hedging is margined, then a fund manager isn’t necessarily reducing risk – they may just be replacing one risk with another. Sure, FX volatility is no longer a concern, but finding liquidity at short notice to settle margin calls is. 

Over time, a fund manager might have to add more collateral to cover a growing mark-to-market position which can be costly and stressful. If the fund manager runs out of free cashflow, they might have to liquidate positions at unfavourable prices and for illiquid strategies, this isn’t a viable option at short notice. 

With no margin hedging, fund managers can better forecast future cash flows as they are not at risk of daily margin calls. They can therefore focus on the core task at hand, maximising returns.

What is Stopping Fund Managers Accessing No-Margin Hedging?

So, if no margin FX hedging is such a no brainer for many fund managers, what’s stopping them from accessing it? 

Surveying the market

In our recent MillTechFX survey of 250 senior finance decision makers at fund managers, 34% stated that securing credit lines was their biggest challenge when dealing with FX. It found that for 88% of fund managers, it took between 6 months and 1 year to setup their current FX infrastructure.

The first step in securing an uncollateralised hedging facility is successfully navigating the banking marketplace to find suitable partners. Different banks have differing levels of appetite for unmargined FX facilities, so it can be a daunting task knowing which bank to approach first.

Fund managers typically run lean operations and time is a scarce resource, meaning researching the market and pro-actively finding banks who will offer no margin hedging is challenging.

Even after a suitable counterparty has been engaged, the approval process for any type of credit facility can take time, and the outcome is not a foregone conclusion. This means a large amount of time and resources can be invested by a fund manager upfront and they don’t necessarily get the desired result of a no margin facility.

What about Best Execution?

Our research showed that 42.8% of fund managers said that demonstrating best execution was the most challenging aspect of their FX operation. For a fund manager, satisfying best execution means having multiple FX counterparties at your disposal every time you trade.

Any fiduciary firm should consider best execution as a core component of best practice and not simply a regulatory obligation to satisfy. Pursuing best execution has other positive impacts too, notably the reduced transaction costs as a result of increased competition between counterparties.

Finding a bank that offers no-margin hedging and subsequently getting the FX facility approved and opened over the following months can be challenging enough - finding multiple banks that all offer equal terms could place a significant strain on internal resources.

The Solution 

The good news is there is new technology and solutions which provide the best of both worlds – margin-free hedging with transparent best execution which can be set up in a matter of weeks instead of months.

This simultaneously enables transparent pricing without the cash drag associated with having to fund initial and variation margin calls, thus supporting key aspects of best execution.

These solutions are available now for fund managers to access. The technology is ready, easy to onboard – and in the future, this could be applied to a wider audience. It’s time for fund managers and other players to seize this opportunity and improve efficiency in FX, today.

How MillTechFX can help

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 helps institutional investors and managers significantly reduce both FX costs and operational burden associated with FX execution and rolling hedging requirements.

We provide 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. Our offering also includes an innovative margin-free hedging solution that removes the need to post initial or variation margin on FX forwards and frees up capital to increase operational efficiency without jeopardising best execution. *

To find out more about our margin-free hedging solution, get in touch with here.

 

*Excludes any required regulatory margin.