British and other European private equity firms that utilize currencies other than their base currency typically deal with various foreign exchange risks. As the financial world is becoming more interconnected, central banks of different countries are pumping significant amounts of money into the system, making bolder decisions is now commonplace. Keeping this in mind, it’s not surprising to know that private equity firms are now dealing with more complex foreign exchange hedging decisions if they wish to safeguard their businesses against exchange rate volatility.
The Different Factors that Influence Volatility
Private equity firms must familiarize themselves of the following factors that can impact currency markets:
- Central bank interest memorandums
- Unscheduled political announcements
- Elections
- Announcement of inflation figures
- Trade statistics
- Specific economic events
- Natural disasters
- Political uncertainties
While the currency markets are regarded as oceans of liquidity, the factors enumerated above influence its volatile nature. Depending on the type of world events, the foreign exchange markets may be illiquid as well. Volatility can result in drastic movements in foreign exchange rates. Increased volatility is becoming more common over time as global trading increases.
The increased use of electronic and mobile platforms as well as algorithmic and high-frequency trading programs among foreign exchange traders will inarguably start pouring speculative funds further into the market.
Various Challenges and Risks Faced by Private Equity Firms
Transactional Risk
Transactional risk pertains to currency volatility that may have a favorable and unfavorable effect on the purchase and sale price of assets.
Net Asset Value and Purchase Exposure
By holding foreign assets within funds, trends in foreign exchange can influence the net asset value within funds.
Management Fees and Expenses
Receiving management fees in a different currency to the base currency of the fund.
In the existing political and economic landscape, the volatility of the foreign currency exchange markets will continue. With this in mind, private equity firms and investment vehicles that are heavily involved in cross-border investments or manage investee companies with significant foreign exchange expenses and revenues must know how to effectively manage the risks.
One excellent way to reduce the negative effects of volatility is to develop a strategic plan while the market is stable and trading goes more smoothly. In this way, firms can get the best pricing in liquid markets. Taking a proactive approach will help private equity forms avoid unnecessary risks that usually come with making decisions hastily.
There will always be a chance for unexpected events to disrupt market conditions at any time. It is therefore best to actively hedge significant foreign exchange risks than assuming business will go on smoothly.
Private equity forms need a reliable and seasoned foreign exchange partner that thoroughly understands the needs of your business and the industry you’re in. As an independent business consulting form with years of expertise in foreign exchange markets,
Damalion experts can provide you with the necessary support you need to open a bank account to mitigate fx exposure and to create a comprehensive strategy that fits your fund requirements. Our experienced Damalion consultants can recommend various hedging options, including forward contracts and foreign exchange options. We will formulate the best solutions to minimize risks and your exposure when dealing with various currencies. Damalion has been supporting the private equity sector for years, and our wide range of hedging solutions can help you prepare for any type of scenario moving forward. If you would like to know more about our business solutions, reach out to a Damalion expert today.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.