Collective experience has illustrated how impactful periods of volatility in foreign exchange rates can be for managers of funds with currency exposures. Such exposures can arise as a result of a multi-jurisdictional investor base, cross border transactions or assets held in underlying portfolios which are denominated in a different currency to the base currency of the fund.
While market volatility can create windfall benefits, investors are often focused on potential downside risk. For some managers, fluctuations in foreign exchange rates following the global financial crisis, the de-pegging of the Swiss Franc, Brexit and COVID-19, among others, resulted in the erosion of hard earned value and dampened their return on investments.
Following a trend set by US managers, European managers now regularly implement fund-level hedging strategies to manage foreign exchange rate risk in their funds and protect value.
Managers have a wide variety of options when it comes to implementing fund-level hedging strategies however there are a number of legal, regulatory and practical aspects to fund-level hedging of which managers should be aware. Different strategies have different pros and cons. We regularly advise a range of managers, from sophisticated, frequent users of derivatives to managers that are in the early stages of thinking about fund-level hedging.
We have established strong relationships with the leading commercial advisers in this space as well as the banks and other financial institutions active in the derivatives market. This allows us to put hedging arrangements in place quickly, efficiently and cost-effectively. Our considerable experience means that we are attuned to the points that are most important to managers and know what the banks and other financial institutions can accept. Just as importantly, our market-leading financial services, funds, financial sponsor and fund finance practices ensures that we are able to advise managers on the continually evolving regulatory landscape and understand how fund-level hedging interacts with the structure of the fund, its underlying investments and any credit facilities.
In this space Travers Smith can help with:
- The establishment and operation of hedging platforms, used for FX overlays in liquid equity strategies as well as to manage investment and divestment processes for more illiquid equity and debt assets.
- Negotiation of ISDA master agreements and schedules, CSAs (Variation Margin and Initial Margin) and cleared derivatives agreements, along with the custody and collateral management agreements required to support such arrangements.
- Regulatory advice, in particular in relation to EMIR. EMIR (and its UK equivalent) is particularly relevant for UK and European managers of UCITS and AIFs, which are highly regulated in this space.
- Optimisation work, to ensure that derivatives and other products are executed in the most efficient way (for example to minimise liquidity demands by ensuring the most favourable regulatory treatment), which can involve elements of fund structuring.
- Development of policies and procedures to assist managers in relation to the above.