What are the FX challenges for Private Equity firms?

Against a backdrop of high inflation, currency volatility and well-documented economic uncertainty, we believe private equity firms should prioritise FX risk management to improve performance, deliver sustainable growth and, ultimately, protect their returns.

Despite the rising importance of FX for private equity firms, many suffer from a lack of transparency across fees, as well as barriers to best execution due to improper infrastructure and cumbersome legacy processes.

Here are some of the top challenges that private equity firms face when it comes to managing their FX risk:

1. Maintaining transparency

Fund managers may often be spoiled for choice when weighing up service providers such as banking partners, subscription line lenders and fund administrators, meaning decisions are often made on fine margins.

Unnecessary costs should be avoided because investors expect that every single pound, euro or dollar generates a return and partners are aiming to surpass their performance hurdle.

Both investors and partners have significant skin in the game, so when they kick the tyres and look under the bonnet of the finance function, they might expect a rigorous audit trail of how costs are being managed and objective decisions are made.

This seems straightforward enough, but it turns out but it turns out that less than 30% of investors have a view of their total FX costs.

2. Managing FX costs

Private equity firms have a fiduciary responsibility to pursue best execution for their clients, so we believe they should have multiple FX counterparties at their disposal every time they enter the market to execute a trade.

As well as having multiple FX providers, fund managers might also want to consider if the financial stability and credit ratings of their chosen counterparties is sufficient. When a fund manager implements an FX policy, we believe they should also consider the following:

• If notional / credit thresholds are of sufficient size
• The credit terms of the facility are in line with their liquidity profile
• If trade tenors match their desired hedging strategy

Many CFOs and COOs can articulate their FX strategy, best performing counterparties and associated credit limits, but few may struggle to say with certainty what their costs are explicitly, and relative to what may have been agreed upfront.

FX costs are usually hidden as an all-in rate which is discounted from the mid. However, it can be hard for fund managers at private equity firms to identify where the mid is and therefore calculate what their costs are on a trade-by-trade basis.

3. Monitoring FX costs

Fund managers at private equity firms can always check what they’re being charged on FX transactions by conducting regular transaction cost analysis (TCA).

TCA goes hand-in-hand with best execution and can be used as an ongoing audit of FX practices as well as hold existing FX counterparties to account.

One major goal of TCA is to gain oversight of trading costs, but additionally it helps to comply with best execution policy, regulation and strong governance expectations from investors and internal stakeholders.

Private equity firms can implement TCA as part of a broader process of monitoring FX costs which includes:

• Finding FX counterparties that can meet your requirements
• Comparing pricing on a trade-by-trade basis
• Capturing trade data for regular, post-execution cost analysis i.e. TCA

However, these straightforward steps are often overlooked.

A recent survey titled ‘The Grey Costs of FX’ drew feedback from various FX industry specialists – 45% were investors, 25% asset owners and 20% either banks or brokers. It found that 39% of the industry is not tracking any TCA for FX.

This is because many private equity firms may still use manual processes to compare pricing, execute trades, and reconcile trade information - namely trade timestamps - which are sometimes not reported accurately by their FX counterparties.

Moreover, for many fund managers at private equity firms, FX is a non-core business activity. This means they commonly get set up with a handful of FX counterparties, with the hope that increased competition bypasses the need to agree upfront costs and monitor them on an ongoing basis.

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 private equity firms 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.

Get in touch today to find out more.