Eddy Verbiest: It is not easy because normally the way to do this would be through a rolling hedge. For Solvency II you need to roll every three months or perhaps less frequently.
The problem with a set up of rolling forward contracts is that the accounting is complex and the link to the underlying market value of the fund is complex.
If it is your first time hedging you need to consult for instance one of the big four to really get the accounts set up and the accounting writing rules for your hedging.
In our experience it is also difficult when you look at your reporting to link the hedging results to the underlying fund results.
“The problem with a set up of rolling forward contracts is
that the accounting is complex.”
Also, to set-up you need the ISDA and other contracts with the investment bank that you are going to work with, and you will need to also take care of EMIR regulations. So it is not easy.
It is easier to do if you just take an average level of currency exposure over a number of years and set up just a few contracts over the long term.
This is easier both for accounting and the link to the underlying, but you still need contracts and take care of EMIR. For this you would want to work closely with the bank as they would be able to help in providing a solution.
An easier way is to set up a hedging fund. There are a number of organisations, such as Lyxor, who provide and can set up a fund that incorporates currency hedging and all the other hedging you need for the amounts you need.
“An easier way is to set up a hedging fund.”
All the contractual work and accounting work is done within the fund and you just have to report the monthly return of the fund which will mostly be negative for hedging funds.
If you regularly finance the fund then in principle you are hedged and from a Solvency II perspective this works perfectly because Solvency-wise you look-through the fund without all the accounting and contractual problems.
Of course, hedging usually costs money but from a practical point of view a fund is the easiest way.
That being said, the currency capital cost after diversification is only something like 5%-6% and so for these kind of funds with these kind of returns in principle I wouldn’t hedge it just for Solvency capital reduction, but instead hedge only if you concerned with dollar movements.
Eddy: If you want to do rolling hedging you need to consult on how to set up your accounts and writing rules to do this hedging. You also need very good agreements with the bank that you are working with.
For the Solvency requirements you will have the counterparty default risk from the contracts, you need EMIR reporting and others and it does take a few months to set everything up if you want to.
It is somewhat easier with a few static hedging contracts but the contracts with the bank will remain the same. Also, you will have to exchange collateral etc. so, it is easier when the bank takes up most of the administration.
It is always the preferred solution if the fund manager themselves can provide in some way a euro share class and do some internal hedging.
“It is easier when the bank takes up most of the administration.”
If you do have a euro share class and some hedging, the own audit and the regulator will usually consider this sufficient and not look further at the efficiency of the hedge.
That being said, the fund solution is much easier as you don’t have to set up anything but the contracts with the fund manager who will set up your hedging fund.
Setting up a fund takes around a month, so it is much smoother than the whole other contractual environment and from then on the only thing you have to do is to communicate clearly with your hedging fund manager to provide the fund with sufficient capital and provide the amounts that you want to hedge and the way that you want to hedge them.
This is by far the easiest solution.
