Why is FX important for Private Equity firms?

The foreign exchange (FX) market is one of the largest and most liquid in the world, with a daily volume of $6.6 trillion. A combination of high inflation, geo-political uncertainty and currency volatility over the past twelve months has placed the importance of having a FX strategy firmly back in the spotlight.

Despite this significant risk, many private equity (PE) firms with currency exposures have given FX policy very little consideration. However, with currency volatility set to persist throughout the remainder of 2023, it is vital that PE firms are aware of how currency fluctuations may impact their returns.

Here are four key ways in which private equity firms might find themselves exposed to FX risk:

• Foreign currency assets
• Impact of FX rate movements on management fees
• Investor Capital
• Indirect, portfolio level FX exposure

1. Foreign currency assets 

 The more jurisdictions a PE managers’ strategy allows for, the greater the number of investment opportunities. But, given that annual movements in even G10 currency pairs can be significant, FX rate movements have the potential to erode long-term value creation efforts or create complications pre-acquisition and pre-disposal.

PE managers commonly implement short-dated hedging to lock in rates during the purchase or sale of an asset, whilst others may even consider hedging asset value throughout the entire hold period.

2. Impact of FX rate movements on management fees

It is not uncommon to see PE managers raise a fund in one currency but have offices outside the jurisdiction of their fund’s base currency.

This means the PE manager receives their management fees in one currency but then has to pay for certain fixed costs, such as salaries and offices, in one or potentially multiple different currencies.

FX rate movements can place a greater strain on management fee income and for that reason PE managers commonly look to lock in exchange rates on expected fee income for as long as possible.

3. Investor Capital

As a PE manager matures, it becomes increasingly likely that they may see foreign currency investors commit capital to their funds. Some managers may take the stance of letting their investors manage their own FX risk, whilst others may implement share class hedging.

Share class hedging mitigates FX risk when investors are considering which funds to commit to and, in that way, can be a useful tool for managers to broaden their investor base and make their funds more marketable overseas.

4. Indirect, portfolio level FX exposure

As a PE manager grows its portfolio, their investment team may have to overhaul how their portfolio businesses manage their FX exposure.

Our own 2023 fund managers FX survey found that 80% of UK and 82% of EU fund managers have looked to diversify FX counterparties since the recent banking crisis, with 87% of those in the EU exploring new technology and platforms to automate their FX operations.

A PE firm may look to align their own set-up and processes with those of their underlying portfolio and hold them to the same high governance standards.

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 multi-bank market helps private equity firms significantly reduce both FX costs and operational burden associated with FX execution and rolling hedging requirements.  

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.

Get in touch today to find out more.