North American Asset Managers Seeking FX Counterparty Diversification
Posted by Colin Lambert. Last updated: September 11, 2023
Following a similar report in July that corporates were looking to diversify their FX counterparties, MillTechFX has now released a survey finding that North American asset managers too are looking to broaden their service provider base.
“Our research shows that fund managers are taking positive action to diversify their counterparty base to avoid having all their eggs in one (or two) baskets,” says Eric Huttman, CEO of MillTechFX. “This not only mitigates counterparty risk, but also provides them with more options, enabling them to compare prices, get more transparency and achieve best execution.
As was the case with the earlier survey, also conducted by Censuswide, the banking crisis in early 2023, which saw two regional US banks go to the wall, was cited as a driver, with 81% of North American managers reporting they are “exploring” diversifying their counterparty base further.
The survey also found that FX risk management is a top priority for fund managers, with 89% saying FX was significant to their business while 82% said US dollar volatility had impacted their business. Over 70% already have a hedging programme in place, while over half (54%) of those without a hedging programme are now considering implementing one.
Other hedging findings include that the average hedge ratio was between 50-59%, with 69% of fund managers stating their hedge ratio is higher than it was last year. The average length of hedges was just under five months (4.96), with 55% of fund managers citing their hedge length as longer compared to a year ago. This suggests that fund managers are moving to hedge more of their FX risk to protect their bottom lines from currency movements, MillTechFX says.
The cost of hedging has gone up over the past year, the survey finds, with 67% reporting that chance, and looking ahead, 47% of fund managers plan on shortening their hedge window over the next 12 months, whilst 46% plan on increasing their hedge ratio.
ESG has also continued its rise up the fund manager priority list with 79% stating that it has grown in importance to their business over the past year, whilst 35% said that the ESG practices of their counterparties were the most important factor in FX. The vast majority (97%) said ESG credentials are a consideration when selecting FX counterparties, while almost half (48%) said that their FX counterparties must have strong ESG credentials.
FX management remains resource-intensive for managers, with 61% of fund managers tasking three or more people with FX-related activities. Despite the resources dedicated to setting up and maintaining their FX processes, only 9% of fund managers said their FX set-up was best in class.
Elsewhere, 78% of those surveyed said they were looking into new technology and platforms to automate their FX operations, while automation of manual processes was the most important factor for fund managers in FX.
The top challenges facing senior finance decision-makers at fund managers in their FX operations are onboarding new liquidity providers (34%) and securing credit lines (33%), the survey finds, adding, unsurprisingly, that transparency is also a major issue for fund managers, with cost calculation (33%) and getting comparative quotes (31%) the third and fourth biggest challenges they face.
Fund managers’ FX exposures come from a range of sources including investor share classes (51%), management fees (48%), foreign currency assets (44%) and within portfolio companies (43%).
“While currency volatility has fallen in recent months, the data shows that fund managers have learnt from last year which saw currency swings erode returns,” observes Huttman. “An increasing number are looking to implement hedging programmes while those which already have them are adding a layer of flexibility by shortening hedge windows which helps reduce costs and the potential for margin.
“That such a small minority of fund managers felt their FX setups were best-in-class is testament to the fact that many see significant room for improvement, especially in light of the fact that the vast majority stated FX was important to their business,” he continues. “Fund managers should look towards tech-enabled, automated solutions to help improve their FX processes.”
“Stakeholders are demanding progress on ESG and, in FX, fund managers are taking this seriously,” Huttman adds. “It’s an important consideration for them when selecting FX counterparties and we have found that many of our clients now ask about our own ESG practices before deciding to work with us which we think is a positive development.
“Overall, the research has reinforced the importance of fund managers having a transparent view of their FX execution, simplifying their workflows and implementing a strong risk management strategy to protect their future returns,” he concludes.