Currency overlay on rise in Asia, says RBC Dexia
The prospect of yield pick-up in emerging markets has among other things attracted global asset managers to invest more in Asian markets and this has stirred demand for outsourcing currency risk management, argues RBC Dexia.
Morgan McDonnell, the firm's head of global FX markets and product based in London, notes that it recently opened an FX dealing desk in Hong Kong, soft-launched to clients six months ago. This adds to its other dealing rooms in Sydney, Luxembourg, Madrid, Paris and Toronto.
Apart from dealing in spot FX, the firm is helping clients to hedge FX risk on foreign currency-denominated investments via instruments such as non-deliverable forwards.
“The dealing desk focuses on interfacing with asset manager clients by providing FX services, including currency hedging and FX structured products," says McDonnell, noting that it works with the firm’s market desks.
As an FX principal dealer, RBC Dexia assumes settlement risk on behalf of clients, but as such, charges a higher mark-up on top of the bid/ask spread that would be earned by an agent broker.
It aggregates thousands of FX positions from clients – whose ticket sizes range from $250,000 to several million – and executes those trades in the market.
But FX dealing by global custodians targeting pension and endowment funds has become tainted after a slew of lawsuits from US states such as California, Florida and Virginia recently. They have accused custodian banks of hiding the actual FX rates at which they executed and overcharging clients by giving them less favourable rates.
For its part, McDonnell says RBC Dexia started providing an FX fee schedule for clients about five years ago, which would be before the global financial crisis. He did not give examples on how the schedule provides a cost break-down, or whether it is possible to show clients how much mark-up premium it charges on top of the spreads it executes at.
He says one practice it follows is to allow clients to see the outsourcing fee it charges for a services mandate, where for example the bank aggregates all client trades throughout the day and does matching and FX settlement.
It reports that fee to help clients understand why it is different from the fee charged to clients who trade FX as an asset class: the latter often pay less as their trades are charged at market prices, he says.
McDonnell adds that currency overlay, or administering hedging based on risk parameters set by the investment manager, is best done by the same custodian bank that calculates net asset value.
"If you acquire a currency overlay hedging programme on the back of an erroneous NAV, your hedging programme can easily go wrong," he notes. "The client would then need to find out who is at fault and seek to reconcile the error.”