Skip to content

Subscribe to Asset Servicing & Fintech Insights

Discover more information in our monthly publication, the AXIS newsletter, including industry trends, product innovation, Fintech and more from our team of experts.

Currency Management: Free Your Team to Add Real Value

As firms strain to hedge currencies amid rising exposures and complexities, many are embracing an upgrade to customized outsourcing. But others are still falling behind.


As seen in Institutional Investor October 2021

Currency volatility poses an increasing risk for institutional investors with significant global assets. Fluctuations in foreign exchange rates among currencies can impact investment returns, adding turbulence and uncertainty to portfolios – as well as constant noise. To address this threat, asset managers and owners know that a vigorous, daily currency management system – armed with a highly focused hedging program – is a vital element to manage risk and enhance returns within their core investment strategy.

Effective currency management and hedging is an increasingly complex and costly burden, adding to portfolio processes and additional non-core risks for sophisticated investors with growing global exposures. As a result, more firms are moving to automated outsourced solutions that can perform this duty far more proficiently and cost-effectively. But others are still struggling with a bias to keep it internal – saddling them with greater workflow burdens, currency volatility and risk of losses from ineffective hedging with each passing quarter.

Currency management is growing more complex and time-consuming

For several reasons – including diversification and long-term sector opportunities – institutional investors are expanding their global exposures, which naturally multiplies the number of currencies and governmental jurisdictions they interact with. At the same time, the critical currency hedging programs they need to protect their investments – which use FX forward contracts or other methods (often in combination) to lessen the negative impact of currency fluctuations on returns – are facing greater scrutiny and regulatory control from governance bodies across the world, making these programs increasingly more complex to manage and maintain.

The combination is making currency management more complicated, difficult, and time-consuming for teams to tackle effectively, straining abilities and stealing effort from other critical functions that are core to the investor’s mission and purpose.

“These increases in international currency exposures are adding risk to the investment performance and increasing the operational burden and cost to maintain their portfolios,” says Andy Lemon, Head of Currency Management for Northern Trust. “Rather than focusing on alpha-generating activities, institutional investors are spending more time and resources focused on responding to the evolving complexities and added risks from their currency exposures.  Many see this as uncorrelated risk on the desk, with only downside operational risk implications and potential opportunity loss by not focusing on enhancing returns."

Rather than focusing on alpha-generating activities, institutional investors are spending more time and resources focused on responding to the evolving complexities and added risks from their currency exposures.

Andy Lemon
Andy LemonHead of Currency Management, Northern Trust

 

A need that’s outgrown the trading desk

Traditionally, foreign exchange hedging and other needs in daily currency management have been front-office tasks that were handled by an employee (or two) that supported the trading desk. “Most institutional investors don't have a currency management desk,” says Lemon. “They have a trading desk, and it may be supported by an operational team – and currency management is a function that someone on this team performs in addition to alpha generation.”

This common model can lead to some undue burdens in light of more modern solutions. The first is opportunity loss, as the team is losing a member to a daily chore that is – albeit complicated and vital – wholly transactional. “The CIO or COO needs to ask, is this time-consuming transactional task best suited for this team and use of talent, or would the trading desk and firm benefit from outsourcing this function to a specialist provider who is able to handle current and future volumes on scale?"

The second risk is that the model can lead to undue errors. The employee that handles currency management typically develops idiosyncratic work processes that – even at large firms with ample resources – often involve spreadsheets.

The third risk is that if that employee leaves, the firm’s competency to manage its currency walks out the door with them. “Management teams will frequently tell us, ‘the person who built the currency spreadsheet left a year ago, and no one knows how to update the macros,’” Lemon reveals. It may be hard to believe that such basic issues can stymie operations at large, sophisticated firms, but it’s an occurrence many are all too familiar with.

If keeping currency management in-house increases the risk of opportunity loss, costly errors, and an integral daily capability exiting at any time, why aren’t all investment firms facing these problems outsourcing it to service providers with specialized, cutting-edge technology?

An old taboo: Keep front-office activities on site

“Historically, we've seen back office and middle office activities being outsourced, from a cost perspective, but the front office wasn't really touched,” Lemon explains. Given the headaches institutional investors are dealing with as they expand their portfolio holdings in global markets, however – plus the upheaval from the COVID-19 pandemic that’s fueling ongoing volatility in global currencies – the operational burdens have now finally become heavier than many asset managers and owners want to bear.

“As a trend, we're seeing more institutional investors asking, ‘how can we outsource our foreign currency management while retaining control and oversight?”, Lemon notes, adding that the movement to virtual work caused by the pandemic has also likely helped make this front-office activity feel more viable to move off site.  

Fortunately, these investors have powerful, cost-effective options to outsource their currency management needs while significantly improving data accuracy, efficiency, oversight, hedging control and performance, risk management, transparency, reporting ease, and regulatory due diligence. But not all outsourced solutions deliver these benefits.

An automated, customizable solution with a holistic portfolio view offers a valuable solution

Before turning their currency management over to a service provider, Lemon suggests that institutional investors ensure their solution has certain essential attributes: advanced automation, ample flexibility for customization and scalability, and a near-real time view of the entire currency management portfolio. Here’s a closer look at these key elements:

Advanced automation

All core data – from a transfer agency, custodian, the middle office, accounting, or wherever it originates – should flow into the platform digitally. If any part of the solution requires manual operations, such as inputting information (like almost every in-house currency management system, not coincidentally), it’s not adding the necessary value.

Automation doesn’t just prevent errors; it brings critical speed. “For example, the system should be automated to calculate the hedges based on your parameters and detect anything unusual immediately, so you can act on it quickly,” says Lemon. For example, AI technology and machine learning can be deployed to analyze every data element to flag anomalies instantly and inform decisions for immediate action.    

Flexible, scalable, customized model

The solution should seamlessly evolve and add capacity as rapidly as your needs change. Using AI-infused automation in technology specifically designed for currency management allows highly customized solutions that meet different requirements for different clients, says Lemon. “It can identify unusual activity that if not detected early could cause downstream issues with incorrect FX deals being booked, so timing is critical,” he says.

Lemon explains, institutional investors may want to utilize a dynamic hedging model and adjust the hedge ratio from 100% to 70% based on market triggers. Or only hedge the portion of a large holding that’s in Turkish lira. Or use proxy hedging to gain correlated exposure to restricted currencies in Brazil, Chile, Taiwan, or Indonesia without the need for NDF execution.   An optimized dynamic hedging model can automate each of these functions, and countless others, to create an intricately customized solution for each client, Lemon says.

Near real-time view of entire currency portfolio and share class divergence

Data visualization tools can provide a comprehensive, near real-time view of their currency portfolios, with interactive interrogation features that allow users to drill down to highly specific needs, says Lemon. “They allow you to be proactive and quickly determine the cause of any problems, so you can pivot as needed,” he says.

For example, if the dashboard shows a blip in hedging performance, an optimum platform allows you to answer most critical questions within seconds. What is causing this delta? Is my hedge offsetting the spot risk I have on the exposure? Is my hedge ratio too low causing performance slippage? Having a holistic data-visualization platform that clearly displays your currency status allows you to solve such issues with the speed necessary to protect your assets, Lemon adds, while systems without this feature may be of little more help than the spreadsheets previously used.

Free talent to add more value

As more institutional investors determine that their in-house currency management process requires too much time, effort, and attentional resources to be viable – and technology upgrades would prove too costly – Lemon expects that these factors may increase the pace of the current transition to outsourcing. “Given the clear advantages, I see outsourced currency management becoming the norm in the near future,” says Lemon. Implementing advanced solutions that meet the criteria outlined above may help to reduce operational costs and Lemon notes that this can then allow management teams to shift resources to core investment activities, generating more value for investors.

 


This marketing communication is issued and approved for distribution in the United Kingdom and European Economic Area by The Northern Trust Company, London Branch (‘TNTC’) or Northern Trust Global Services SE (‘NTGS SE’). TNTC is authorised and regulated by the Federal Reserve Board; authorised by the Prudential Regulation Authority; subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. NTGS SE is authorised by the European Central Bank and subject to the prudential supervision of the European Central Bank and the Luxembourg Commission de Surveillance du Secteur Financier. View full disclaimer.

Andy Lemon

Head of Currency Management, Northern Trust
Andy Lemon is the Head of Northern Trust’s Currency Management team and is based in London.

  

Related Content

We explore why outsourcing FX currency management may help achieve operational resiliency, reduce risk and enhance performance while saving costs.

A report summary of insights from discussions with traders and operational professionals in collaboration with The Finance Hive.

Confidentiality Notice:  This communication is confidential, may be privileged, and is meant only for the intended recipient.  If you are not the intended recipient, please notify the sender as soon as possible.  All materials contained in this presentation, including the description of Northern Trust, its systems, processes and pricing methodology, are proprietary information of Northern Trust. In consideration of acceptance of these materials, the recipient agrees that it will keep all such materials strictly confidential and that it will not, without the prior written consent of Northern Trust, distribute such materials or any part thereof to any person outside the recipient’s organization or to any individual within the recipient’s organization who is not directly involved in reviewing this presentation, unless required to do so by applicable law.  If the recipient is a consultant acting on behalf of a third party client, the recipient may share such materials with its client if it includes a copy of these restrictions with such materials.  In such event, the client agrees to comply with these restrictions in consideration of its accepting such materials.

© 2022 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability as an Illinois corporation under number 0014019. Products and services provided by subsidiaries of Northern Trust Corporation may vary in different markets and are offered in accordance with local regulation. This material is directed to professional clients only and is not intended for retail clients. For Asia-Pacific markets, it is directed to expert, institutional, professional and wholesale clients or investors only and should not be relied upon by retail clients or investors. For legal and regulatory information about our offices and legal entities, visit northerntrust.com/disclosures. The views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author's employer, organization, committee or other group or individual. The following information is provided to comply with local disclosure requirements: The Northern Trust Company, London Branch, Northern Trust Global Investments Limited, Northern Trust Securities LLP and Northern Trust Investor Services Limited, 50 Bank Street, London E14 5NT. Northern Trust Global Services SE, 10 rue du Château d’Eau, L-3364 Leudelange, Grand-Duché de Luxembourg, incorporated with limited liability in Luxembourg at the RCS under number B232281; Northern Trust Global Services SE UK Branch, 50 Bank Street, London E14 5NT; Northern Trust Global Services SE Sweden Bankfilial, Ingmar Bergmans gata 4, 1st Floor, 114 34 Stockholm, Sweden, registered with the Swedish Companies Registration Office (Sw. Bolagsverket) with registration number 516405-3786 and the Swedish Financial Supervisory Authority (Sw. Finansinspektionen) with institution number 11654; Northern Trust Global Services SE Netherlands Branch, Viñoly 7th floor, Claude Debussylaan 18 A, 1082 MD Amsterdam; Northern Trust Global Services SE Abu Dhabi Branch, registration Number 000000519 licenced by ADGM under FSRA #160018; Northern Trust Global Services SE Norway Branch, org. no. 925 952 567 (Foretaksregisteret) [VAT if applicable], address Third Floor, Haakon VIIs gate 6 0161 Oslo, is a Norwegian branch of Northern Trust Global Services SE supervised by Finanstilsynet. Northern Trust Global Services SE, address 10 Rue du Château d’Eau L-3364 Leudelange Luxembourg, B232281 (Registre de Commerce et des Societes), is authorised and supervised as a credit institution by the ECB and CSSF. The Branch has its registered office at Grosspeter Tower, Grosspeteranlage 29, 4052 Basel, Switzerland, and is authorised and regulated by the Swiss Financial Market Supervisory Authority FINMA. The Northern Trust Company Saudi Arabia, PO Box 7508, Level 20, Kingdom Tower, Al Urubah Road, Olaya District, Riyadh, Kingdom of Saudi Arabia 11214-9597, a Saudi Joint Stock Company – capital 52 million SAR. Regulated and Authorised by the Capital Market Authority License #12163-26 CR 1010366439. Northern Trust (Guernsey) Limited (2651)/Northern Trust Fiduciary Services (Guernsey) Limited (29806)/Northern Trust International Fund Administration Services (Guernsey) Limited (15532) are licensed by the Guernsey Financial Services Commission. Registered Office: Trafalgar Court, Les Banques, St Peter Port, Guernsey GY1 3DA. Northern Trust International Fund Administration Services (Ireland) Limited (160579)/Northern Trust Fiduciary Services (Ireland) Limited (161386),  Registered Office: Georges Court, 54-62 Townsend Street, Dublin 2, D02 R156, Ireland.