How MUFG Investor Services’ leading FX solution manages currency risk effectively

As volatility rips through financial markets and wild currency swings become the norm, the art of currency risk management is becoming increasingly complex

Customised, automated solutions are key to helping funds hedge FX risk intelligently – especially as we adjust to a new era characterised by persistent inflation, rising interest rates and geopolitical and market uncertainties. 

Fast-moving FX markets

FX is often an afterthought for fund managers. Equity and bond portfolio managers are a world away from FX traders, yet both must pay close attention to the world’s largest financial market, with a daily volume of $6.6 trillion. Currencies move hard and fast these days.

In 2022, the US dollar index – which measures the greenback against a basket of six currency peers – hit a 20-year high. Since the beginning of the year, the dollar was up as much as 33% against the Japanese yen, 30% against the British pound, 20% against the euro and 12% against the Indian rupee.

Hans Jacob Feder, global head of FX services at MUFG Investor Services, explains: “Since last year there has been heightened volatility in FX due to inflationary pressures, the Russia-Ukraine war, supply-side issues and so on. This, of course, impacts investors in that they experience increased volatility.”

Large FX moves can wipe out portfolio gains. A Japanese investor in a low-income, dollar-denominated fund would have seen returns take a knock last year when exchanging dollar returns into yen, as the yen tumbled against the dollar to a 32-year low.

The complexity of managing these wild currency swings is exacerbated by regulators’ demands for more granular trade reporting and customers’ desire for greater transparency on their hedges. Increasingly, portfolio managers seek a partner that can understand the complexity of their business and take over their hedging needs. 

Feder says MUFG Investor Services specialises in passive currency overlay solutions for asset managers. He explains: “Due to increased regulation, the complexity of hedging has grown, and investors want more transparency around exactly how you hedge for them and the operations around hedging. Buy-side firms – who are not themselves FX specialists – are finding it increasingly complex and difficult to continue to hedge in-house.”

It can take more than a simple spot or forward trade to combat the devastating impact of downside currency moves and satisfy both regulators and customers. With this in mind, MUFG Investor Services has placed a focus on getting under the hood with every client, offering customised deliverables. MUFG’s FX Overlay (FXO) solution provides an outsourced, non-discretionary, rules-based hedging service that addresses clients’ challenges when mitigating FX exposures within a portfolio or hedged share classes.
 

The FXO solution

MUFG Investor Services FXO delivers a comprehensive, flexible, cost-effective and transparent currency overlay solution for asset managers and asset allocators, and supports multiple fund structures. MUFG Investor Services combines the power of a multi-broker/dealer electronic execution and full transparency to offer clients competitive prices and comply with best execution rules under the second Markets in Financial Instruments Directive, while facing MUFG Investor Services as the FX counterparty. 

Most FX providers are limited by their own pricing, as they don’t source the best prices from the street. The other option of going it alone can be costly and short-sighted, as FX hedging requires great skill during periods of rapid market moves when dynamic hedging reigns supreme. 

MUFG Investor Services continues to work with clients to build bespoke hedging models using market-leading tools spanning over 100 technological variables per hedged currency pair. These are fully automated, redundant and secure, with multiple levels of oversight to ensure accuracy and robust operations. Once the FX hedging parameters are agreed upon, MUFG Investor Services interacts with its clients as a riskless principal.

FXO offers share class and portfolio hedging to minimise the currency risk linked to foreign currency-denominated share classes and portfolios containing foreign-denominated exposures. Look-through hedging provides hedging of underlying portfolio positions and index tracking gives the ability to mimic industry-offered indexes:

• Share-class hedging: reduce the FX risk of foreign-denominated share classes to better track the main share class.
• Portfolio hedging: hedge foreign currency-denominated assets of a portfolio back to the base currency.
• Look-through hedging: provide hedging of underlying portfolio positions and net with a share-class offering.
• Index tracking: mimic industry-offered indexes, such as the MSCI World Index. 
   

Credit is king

As part of one of the largest banks worldwide, MUFG Investor Services has competitive financing options for clients that need help with their margin needs. FXO clients can benefit from MUFG Investor Services fund administration services and fund financing services for operational support, such as lines of credit for use as synthetic margin for FX trades to create a holistic FX hedging offering.

Feder says: “We have numerous ways to deal with the credit aspects of hedging. I think we are unique in that we are quite a large firm for providing financing that clients can use to post margin, which many others do not.”

Margin is at the forefront of everyone’s minds. Following the demise of the family office Archegos Capital Management, Credit Suisse, and Nomura were left billions of dollars out of pocket. With volatility battering markets, clearing houses demand more collateral in the form of initial and variation margins. 

Margin is a common problem for funds of funds wanting to hedge currency risk. A loss on a FX hedge will usually result in a margin call, which means putting aside funds that would otherwise be invested in the fund. MUFG Investor Services can offer less liquid clients financing to secure synthetic margins or even scrap margins altogether. 

In addition, MUFG Investor Services can also operate on an account control agreement, which means there is no cash movement of collateral but rather a lien over a set of assets, in case of default by the client. 

Feder says: “Posting margin implies the fund might be under- or over-invested because they have to keep cash aside for margin. Because of increased volatility in FX, funds will have to keep more cash aside for margin than previously. This means having a credit solution is even more important to allow them to be fully invested.”
 

Case study: a bespoke solution for a fund-of-funds client

Off-the-rack currency management solutions have their limits – particularly for more complex needs. This is where MUFG Investor Services differentiates itself from other players and has the edge over white-label FX solution providers. Feder shared how they partnered with a buy-side customer to tackle its currency hedging needs.

A client wanted to launch a new fund with multiple layers of currency exposure. The fund had a base currency and a share class requiring share class hedging; it also invested into other funds, such as a fund of funds, which in turn were denominated in different currencies. Each of those investments could have a portfolio. A pan‑European-based fund might have some investments in Sweden or Norway, generating another level of currency exposure. 

MUFG Investor Services was able to work with the client to design a completely bespoke hedging solution. It tracked the entire chain, looked all the way down to the final level, rolled it all up, netted across each layer of hedging, then found the right way to put on the hedges. 

It’s not simply a case of netting each layer because these legal entities are different, each needs a specific FX trade attached to that legal entity. As Feder explains, even when netting, it’s necessary to break each layer down into its components, which presents quite a challenging bespoke currency requirement. 

 “We were able to come up with an end-to-end solution, which generated a report that showed this breakdown, providing the transparency the customer needed to make sense of it all. We feel there are few platforms in the industry that could have given that level of customisation.” says Feder.

Whether clients never hedge, partially hedge or are fully hedged, now is the time to be aware of the impact of FX and make an action plan. 

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