With currency volatility expected to rise in 2024, more corporate treasuries are exploring hedging strategies to mitigate foreign exchange (forex) risk. While forwards and swaps are common choices, options provide unique advantages that make them appealing for certain firms. This article examines the basics of FX options hedging and key strategic considerations for implementation.
Recent developments, particularly out of the UK, indicate a trend where pension funds are capitalizing on higher interest rates to transfer risk off their balance sheets to insurance companies.
Improving Pension Funding Status:
Contrary to the challenges often associated with rising interest rates, it's important to note that higher rates can be advantageous for pension funds. As interest rates increase, the present value of future defined pension liabilities decreases. This has meant that the pension funding status at many institutions is the best it’s been in years.
Pension Risk Management - Opportunities for Risk Transfer:
With an improved funded status due to higher interest rates, pension funds are increasingly exploring opportunities to offload the risk of meeting those obligations from their balance sheets. This is often achieved through the transfer of pension liabilities and assets over to an insurance company to manage, a move that allows companies to focus on their core objectives while mitigating the cost of running a pension scheme or the risks of having to make pension deficit contributions to cure an underfunded status.
Impact on Private Market Assets:
To prepare for risk transfers to insurance companies, pension funds are rushing to offload private market asset portfolios, with Bloomberg reporting that over 200bn GBP of private equity, credit, and infrastructure assets may be sold over the next couple years, decades sooner than previously expected. This rush has resulted in some funds accepting discounts of up to 40% on these assets.
Pension Fund Interest Rate Risk Management:
The risk from interest rates falling faster than expected this year is precipitating a lot of activity in the sector and highlights the need for prudent pension risk management around interest rates. Our technology and advisory firm works closely with funds to help them better understand their exposure to interest rate risks on both the asset and liability side, so please reach out to start a conversation.
