Dispelling the myths around FX hedging and FX risk

CalendarNovember 9, 2022

by Lead Monitor

Misconceptions around FX hedging and risk may lead to missed opportunities for funds and portfolio companies. How are new technologies and platforms serving both to educate practitioners, and democratise access to FX expertise?

When it comes to developing hedging and risk management strategies, many in the field believe it is important for funds and portfolio companies not only to have good working relationships with their brokers but also to have a solid understanding of the tools at their disposal. Effective hedging may improve working capital management and reduce cash flow risk, while emerging technology in this space can improve visibility into business and fund valuations.

Within this field, FX hedging is generally employed by fund and portfolio managers to help protect their business’s position in a currency pair from negative equity, and tends to be used when a trader is concerned by volatility in the currency markets.

Traders, businesses and brokers may hedge by using one of two main strategies: either placing a hedge and taking the opposite position to the asset that they are hedging (a ‘currency swap’), or by buying FX options. Both strategies require access to reliable real-time data to convey accurate information.

Until recently, this technology was primarily provided by traditional banking institutions. The emergence of new fintech players on the scene has enabled brokers, traders and businesses of all sizes to access data from different sources in different formats, providing a more detailed view of the marketplace, and leveraging this information to help inform their FX hedging decisions.

Making FX hedging accessible

According to Jonathan Gardner, director & head of business development at cross-border payments solutions provider Corpay, the increased accessibility of new technologies may have gone some way towards counteracting common misconceptions around FX hedging and FX risk.

“What you can get from these newer platforms is the ability to stay nimble,” Gardner says. In Corpay’s case, we have a proven product suite of forwards and options. For any client looking to hedge, we have a wide range of products available.”

With new platforms unlocking new possibilities, Gardner’s opinion is that the most crucial aspect of combating misconceptions within the FX hedging space is education.

“A lot of companies that we deal with have a fiduciary responsibility to their own clients and shareholders, and that can account for most of the caginess that we see,” he explains.

Challenging misconceptions about FX hedging

The reason that funds and portfolio companies may have neglected FX hedging as a viable capital management strategy, Gardner says, can be attributed to risk aversion and lack of comfort around how to navigate what tends to be a very volatile space.

The recent chain of major market-shifting world events may have only compounded fund managers’ uneasiness. There is much work still to be done within the FX hedging space as a whole, to continually educate prospective clients to address some of their concerns relating to hedging. Conversely, there are other clients who have been able to manage the market volatility, in part perhaps owing to their close and clever readings of the marketplace.

“Sterling has only recently started to display higher volatile tendencies, a result of Brexit, the cost-of-living crisis, the pandemic, and more recently the conflict between Russia and Ukraine,” Gardner says.

By maintaining an eye on current trends within the FX hedging space, and keeping apprised of appropriate tools and platforms available on the market, funds and portfolio managers can start to combat some of this hesitation, and the perception that hedging might be inaccessible or too complicated. With greater knowledge and comfort, they may be able to turn market volatility to their advantage.

AI is helping finance teams identify patterns, making hedging decisions simpler and quicker,” Gardner says. “Certainly, we’re hoping to see more predictability come into the hedging market with the development of AI and the ability to spot patterns, which previously might have been inaccessible to those relying on intuition alone.”

“What developing technologies and platforms like ours have made people realise is that you don’t have to be reliant on traditional banking institutions: there are alternatives.

“Consequently, we have a lot of private equity and venture capital funds who are looking at the latest innovations and trying to make their own predictions about what could be the next big disruptor to the FX hedging space. New technologies, including scenario planning technologies, can harness information that empowers the client to make more informed decisions in creating their hedging strategies. They can then come to us to execute that strategy.”