Where appropriate and permitted by the board, the investing institution may adopt an investment strategy that reduces its exposure to unwanted currency risk, while noting that, for some investments, potential currency movements may form part of the expected return and/or an extreme risk hedge and, therefore, should not be managed (or “hedged”).
Guideline code
INVEST_03300
Mechanism
Mechanism
- The investing institution can manage (or “hedge”) overseas currency risk by using derivatives such as forward contracts.
- Where an expected change in the value of currencies forms part of the expected positive return on investments, currency exposure should not be hedged. For example, where an investing institution invests in an asset that is denominated in a currency that it believes to be undervalued, the expected appreciation of the currency will, therefore, form part of the return expectation of that investment, as well as increasing the risk associated with that investment.
- Hedging currency exposure using derivatives may require cash calls from the manager(s) managing the hedge. The investing institution should consider the implications of having to meet such cash calls, including the potential need to liquidate assets at unattractive times or valuations.
- Compliance with the risk management structures set in place to govern the use of derivatives for currency hedging should be carefully monitored.
- Where the board, management or investment committee lacks sufficient resource, expertise or governance budget to monitor and implement currency hedging, the board, or the management or investment committee with board authorization, should seek expert advice or appoint external professionals to carry out these functions.
Structure
Structure
- Where the investing institution invests in overseas assets it should consider managing (or “hedging”) its exposure to the change in value of the currencies in which the assets are denominated (where it believes it is an unrewarded risk in its portfolio).
- For some investments, the expected change in the value of currencies may form part of the expected return and so should not be hedged. Alternatively, it may be considered likely that a time of extreme economic stress would also see significant depreciation in the domestic currency and, therefore, unhedged foreign assets may provide a degree of protection against those scenarios (i.e. they provide an extreme risk hedge).
- An appropriate hedge ratio (or ratios) should be determined, which may differ by region and/or asset class.
- An appropriate level of currency risk to be hedged should be determined by the investing institution, together with external experts if required. The institution should avoid hedging too much currency risk.
- The liquidity implications and cost of currency hedging should be considered.
- Appropriate risk management structures should be set in place to govern the use of derivatives for currency hedging.
Title HTML
Guideline 28. Currency hedging
Type
Guideline_1
Weight
37