Today, June 17th, EMIR 2.1 is to be implemented. The reason why you may be unaware of this amendment is because it only impacts a minority of funds. It is however always good to stay informed to know for sure whether EMIR 2.1 may or may not impact the categorisation of your fund.
Up until now, EMIR categorised any EU or non-EU Alternative Investment Fund (AIF) that is managed by an EU AIFM authorised or registered under the AIFMD as a Financial Counterparty Now this definition has been extended to include:
“Any EU AIF, irrespective of the location or status under the AIFMD of its manager and where relevant, a fund’s AIFM established in the EU.”
Casting our minds back to 2017, those of you that hedged fund level FX with forwards will remember bracing yourselves for the requirement to exchange collateral as margin on a daily basis. As things turned out, after much remonstration the use of FX forwards as a hedging tool was made exempt from the daily margining requirement, much to the relief of many.
Last week JCRA co-hosted a breakfast meeting with Travers Smith where we discussed FX hedging and margining, amongst other subjects. With FX hedging there is often confusion as to whether daily margining is required, because deliverable forwards are out of scope but non-deliverable forwards (NDFs) are in scope for Financial Counterparties. When hedging fund level FX risk a rolling hedging programme involves settling the mark to market rather than delivering the full notional of the trade. The reason why this approach circumvents the mandatory clearing and uncleared margin requirements is that the ultimate goal of the rolling hedging programme is to settle the contract. This is very different from a ‘real’ NDF contract, for example in the case of emerging market currencies, when the only option available off-shore is to cash settle.
Over the last few months we have seen a significant jump in advising funds looking to buy assets in South America. Here returns can still be significantly higher, but so are the risks. Hedging currency risk in some emerging market currencies has become significantly less expensive, especially for US dollar denominated funds. This is due to emerging market interest rates falling while rates in the US have tightened. Although never a one-way bet, emerging market currencies have weakened over the last 10 years. If you calculate the average annual depreciation in these currencies and compare them to the cost of hedging, if the cost of hedging turns out to be considerably lower, then this could be an encouraging reason to hedge your exposure.
Food for thought?
This surge in emerging market related enquiries is evidence of an increase in appetite for funds seeking higher returns. As inflation expectations in the EU hit a record low, you can see why funds need to look further afield.
Upcoming economic data
The US market will be focussed on any indications from Powell with regards to policy loosening on Wednesday evening.
In the UK the Conservative leadership battle is expected to narrow the race to be PM down to two. Otherwise retail sales will be closely watched to see whether the consumer continues to shrug off Brexit anxiety.
In Europe, following on from Draghi’s comments that the governing council is keeping a close eye on inflation expectations, the release of CPI on Tuesday will be key.
For more information, please contact Chris Towner, Director at JCRA, at email@example.com.