Operational Alpha Series

FX Margin Calls and Increased Collateral Demands and its effect on a funds AUM.

Over the past year, we have seen vast amount of regulatory pressure being imposed upon the financial services sector, which is forcing banks to look at the risk on their balance sheets. Taking the brunt of this added regulatory burden seems to be emerging fund managers.

The British public have spoken regards to the EU referendum and shocked the markets with a vote for a BREXIT and as traders and investors look to what’s next the only thing that we can agree on is that the only certainty is uncertainty and it is clear that we are in for extreme volatility. Premiums are expensive, and margin calls will certainly be an issue.
Cash is king right now. The main question is how does an emerging fund manager maximize his/her skin in the game when banks are asking for up to 20% deposits to cover an international share class or asset?

One solution could be to simply look for alternative hedging solutions away from the traditional Prime Brokerage and Custodian Banking relationships. AFEX offers alternative credit facilities away from the PB, freeing up valuable AUM that could be put to work and generate real alpha.

Scenario:
PE Firm USA
Acquires an asset in France for 10m EUR through PE Firm KY SPV
USD value of asset = 11.4m USD (based on SPOT rate of 1.14)
PE Firm KY SPV decides they want to protect the investment against USD strength using a rolling EUR/USD hedge 10m EUR sell forward 3 months.
Bank requests 10% deposit to book the forward contract hedge (1m EUR) however PE firm KY SPV is fully vested and there for cannot post collateral without cash calling investors for another 1.14m USD.

In this situation, the SPV was unable to post collateral. Therefore, it would potentially fall on PE Firm USA to either post collateral on the SPV’s behalf or leave the asset unhedged. This causes an exposure to EUR weakness or USD strength which could obviously severely affect the profitability of the transaction.

Solution
After looking at the fund structure, the NAV, and the underlying asset, AFEX was willing to offer the PE Firm KY SPV its own OTM of 3m EUR. This meant that the entity did not have to post any upfront collateral with the bank, and instead had a margin call limit of 30%.
AFEX understood PE Firm KY SPV’s needs and requirements and created a solution that was bespoke and fair, not to mention gave the client the flexibility he needed to navigate an extremely volatile week in the FX markets and avoid a margin call.

About the Author:
Ashley Groves – AFEX – Director, FX Risk Management – agroves@afex.com – 646 231 7804

Ashley has been in the FX industry for over 10 years in a variety of positions. At AFEX he is currently responsible for the acquisition, management and maintenance of corporate, institutional and high net worth clients. Specifically focused on the Alternative Investment space in North America, over the years Ashley has created a vast network of highly skilled professionals that can assist with every aspect of a cross border transaction.

Ashley holds a BA honors degree in Services Marketing and Economics from the University of Bournemouth in England. In his spare time Ashley is an avid rower, and raced at Regatta’s across the country at both collegiate and club level.

About AFEX:
AFEX is a trusted global payment and risk management solutions specialist with a heritage that dates back to 1979. Over the past 37 years, AFEX has garnered a reputation as the premier non-bank provider of FX in the world. This year AFEX has executed $20bn in cross border transactions on behalf of their clients, across all industry sectors and asset classes through a full suite of deliverable SPOT, FWD, NDF’s and Structured Products, in all major and minor currencies.

Leave a Comment