Are You Ready for Changes in the FX Markets?
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Are You Ready for Changes in the FX Markets?

Currency markets are undergoing a major structural change. What does it mean for investors?

From January 2018 onward, major new regulations brought about by the Markets in Financial Instruments Directive (MiFID) II will affect everyone trading on foreign-exchange (FX) markets across Europe. While the general aim of the new requirements is to promote competition and transparency across financial markets, they could also result in additional costs and complexity for investors who are seeking to manage currency exposures effectively and/or comply with their own fiduciary obligations.

Changing FX markets

The increased globalization of investment portfolios and the large exchange-rate movements caused by divergent monetary policies in major currency areas have intensified currency-hedging activities in the FX markets. At the same time, regulatory changes have reduced the number of dealer banks that are willing to warehouse risk, leading to a decline in market depth and functionality. Changes in liquidity conditions could increase market risk and reduce the effectiveness of the hedging strategies used by investors. As a result, effective currency risk management is becoming more important than ever.

MiFID II, which will require financial institutions to achieve and demonstrate best execution using pre- and post-trade transaction cost analysis, will have additional implications for FX markets. The increased disclosure and reporting requirements are likely to favor electronic trading systems. This could bring about lower spreads under stable market conditions, but could also further reduce risk-absorption capacity when market conditions deteriorate. Since traditional ways of conducting FX transactions may no longer be optimal, the ability to monitor and access the FX markets – with their daily trading volume of USD 5 trillion – in the best possible way will become ever more important.

Growth in currency-market trading volume by instrument

Growth in currency-market trading volume by instrument

Why delegate currency management?

Unmanaged currency exposures in a portfolio are an unrewarded risk. On the other hand, implementing a hedging strategy in a timely and disciplined manner, which is a requirement for effective currency management, can be a hassle. A separate management of currency exposures in a portfolio via a customized currency overlay can provide significant cost-saving synergies for most international investors while also eliminating operational risk.

A delegated currency management solution also offers direct access to experienced specialists with extensive global knowledge, in-depth local-market expertise, and state-of-the-art systems and processes. The design and implementation of a best-practice currency management solution and execution setup that is tailored to investors’ individual needs and circumstances will enable them to make the most of the new and changing world of currency risk management.