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Managing FX: Delivering Alpha via Outsourcing to Investors

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Vincent Bonamy, Head of Global Intermediary Services – GFX & Commodities at HSBC Global Banking and Markets and Gemma Laman, Global Head of FX Platform Sales at HSBC Global Banking and Markets, discuss how outsourcing FX can help asset managers navigate some of the challenging market headwinds facing the industry today.

Asset managers looking to rethink FX processes

Margins at asset managers are gradually being eroded by a combination of bumpy market conditions, rising business costs and increasing competition from passive funds. Exacerbating matters further is that the fees being paid to active managers continue to slide, with management fees falling by 4% in 20211. With the industry grappling with mounting cost pressures, investment firms are seeking out operational efficiencies. FX management is one area where synergies could potentially be realised.

For many traders, managing operational FX is a distraction precluding them from concentrating on their core competences - namely delivering alpha to investors. Moreover, a number of investment firms rely on legacy technology or manual processes when managing FX, which drives up costs further and creates unnecessary risks.

And finally, with regulations such as MIFID II (Markets in Financial Instruments Directive II) imposing strict requirements around best execution, FX management is something investment firms cannot afford to get wrong. All of these underlying factors are prompting managers to re-think their traditional approaches towards FX.

Obtaining operational alpha through FX outsourcing

As a result, there is now insatiable demand among investment firms to outsource FX management to specialist providers. These providers help managers unlock value through FX, in what can have a meaningful impact on performance, not least because it enables traders to focus more of their attention on alpha generation.

Given the effect which market volatility is having on returns, the opportunity to net additional basis points (bps) through optimised FX is a compelling one for asset managers.

Externalising FX can also enable managers to procure significant cost savings thereby allowing them to obtain economies of scale more easily. In addition, outsourced partners can provide managers with invaluable data analytics and KPIs (key performance indicators), something which would not necessarily be available to them if FX was performed in-house.

Case Study 1 - A leading private bank

A leading private bank and HSBC entered into a new strategic collaboration that will enable HSBC to service existing FX risk management mandates of the private bank’s clients. As part of the agreement, the private bank will continue to provide its FX trading signals from its proprietary dynamic currency management strategies to its clients, which HSBC would then execute with those clients. Integrating the private bank’s currency strategies with HSBC’s FX risk management platform will increase the FX risk strategies available to clients.

Accessing restricted markets

Elsewhere, FX outsourcing can support managers who have exposures to restricted – albeit lucrative – markets. Getting to grips with the various rules around FX in these restricted markets can be a difficult and time-consuming process for managers.

For instance, some jurisdictions impose stringent limits on moving domestic currencies offshore, whereas others subject investors to complicated reporting requirements when trading FX. This can often make it difficult for firms when participating in these local markets.

As a fundraising tool in restricted markets, outsourced FX can also play an invaluable role. This is because it can allow managers running global USD, Euro or GBP funds to sell their products to domestic investors in local currencies. This is especially vital given that certain markets have tough capital controls precluding their domestic populations from transferring cash abroad.

Case Study 2 - A large global asset manager

Client Backgroud: The client request was to provide NAV hedged, portfolio hedged and look-through hedged share classes, using 20+ currency pairs, including freely convertible and restricted markets currencies. The clients’ assets are custodied by multiple third party custodian banks. By adopting an outsourced model, the client was able to focus on their core competencies, while transferring the operationally intensive and risky processes to an experienced third party.

HSBC Partnership: HSBC provides a full suite of FX conversion and hedging services with seamless integration into the asset managers’ operations. HSBC created a systematic, scalable and flexible FX risk management workflow for the client which enabled them to optimise operational efficiencies, gain pricing transparency and receive proprietary and third party analytics. This helps them retain control over their hedging programme whilst providing improved operational efficiencies and full transparency on the effectiveness of their hedging parameters, maximising efficiencies and minimising costs to the fund.

Appetite for FX outsourcing is particularly strong among asset managers with commercial interests in China, one of the most strategically important of the restricted markets. This comes as the country gradually liberalises its capital markets through initiatives such as Stock Connect and Bond Connect, both of which enable foreign investors to trade domestic securities more freely.

Similarly, the country is also opening up its distribution channels to foreign asset managers by allowing them to sell products to local investors. For example, Chinese regulators introduced the WFOE (Wholly Foreign Owned Enterprises) scheme - which allows global open ended funds to sell to domestic accredited investors without having to enter into a joint venture with a local financial institution.

Additionally, Wealth Management Connect launched in 2021, which tightens financial links between the southern province of Guangdong and neighbouring Hong Kong and Macau. Under the scheme, mainlanders will be able to access Hong Kong authorised funds, while investors in Hong Kong can benefit from a wider choice of Renminbi products.2 Both WFOE and Wealth Management Connect will likely lead to more foreign managers targeting domestic Chinese investors, which in turn will trigger greater demand for FX outsourcing tools.

Working with the right provider

Although managers are increasingly outsourcing FX, it does not absolve them from their responsibilities. Accordingly, managers should work with only but the leading FX providers, who can offer a consistent and best in class service.

At the same time, investment firms need to ensure their operations are streamlined – something which can be done through counterparty consolidation –and by ideally working with a bank who can offer a wide gamut of services beyond just FX, but also custody, administration, transfer agency, depositary and prime brokerage.

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