How to manage FX hedges in a COVID-19 world
- March 23, 2020
Hedging and Capital Markets
Private Equity | London
The impact of the coronavirus on the global economy, equity, bond, and FX markets is immense. Currency markets have always been a barometer of financial market volatility. They have no physical borders and usually deep pools of liquidity.
Sterling (GBP) is a currency influenced by financial market volatility, due to London’s heavily weighted financial sector. London alone accounts for over 40% of the global seven trillion U.S. dollars traded daily around the world.
In times of crisis, and especially one as intense as the current one, the U.S. dollar is seen as the “hardest” currency and arguably the ultimate safe haven. As a result, we have seen GBP plunging to lows not seen since 1985 at 1.1450 against the dollar. GBP/EUR has come under similar pressure.
However, as is always the case with extreme volatility, opportunities can present themselves. Firstly, those with existing GBP hedges are looking at large positive mark-to-market valuations that could potentially be re-set with the intention of raising cash at a time when liquidity is the key short-term risk. Consideration must be given to the new rate which is being struck, and whether this still fits with the hedging policy.
Secondly, any GBP-reporting business or fund that has unhedged assets overseas may be looking at the current market levels as an opportunity to hedge that risk; with GBP over 10% lower against the U.S. dollar and the Euro since the start of the year. We have the expertise to evaluate exposures and provide guidance as to whether this is the right thing to do, and critically what type of hedging instrument to deploy.
In times of heightened volatility, margin calls from hedge providers are a major concern for many of our clients, in particular those businesses or funds with non-liquid assets. We had helped our clients negotiate higher-threshold, non-secured FX credit lines to act as a buffer to these margin calls but aware that these might now need revisiting. We would also advise others who have agreements in place to check the language carefully about the frequency of these calls and how the counterparty is calculating the margin which is to be posted. Finally, running some quick scenario analysis if further GBP weakness occurs is important to understand what future margin calls might be made. Upfront and transparent communications with your counterparties are critical to secure a favorable outcome.
Should you have any questions on the above, or other market impacts of COVID-19, we are here to assist in any way we can.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.20-0084