Banks tout early roll dates for FX swaps as quarter-end looms

Asset managers open to more flexible hedging strategies since March turbulence, say dealers

second-quarter crunch?

As the end of the first quarter approached amid the dollar funding squeeze driven by Covid-19, some asset managers rolled their FX swaps before month-end to avoid a price jump. As the end of the second quarter draws near, dealers say they’re having conversations with clients about repeating the strategy.

“We are starting to see a small widening of the FX basis as we approach quarter-end with implied yields rising, which may prompt more people to start looking at it,” says Tim Jones, head of international FX forwards at Credit Suisse. 

The wild market moves seen in March have left a scar on investors’ minds, says Jones, and have prompted asset managers to be more open to adopting flexible hedging strategies in future. 

“It wouldn’t surprise me if we see people start thinking about rolling at least a week or two before, and that would be purely on sentiment of what was witnessed in March,” says Jones. 

Andy Lemon, head of currency management at Northern Trust, says it could become a permanent change of strategy for some.

“For some clients what happened in March made them think about whether month-end is the right time to be doing this. We had a lot of good conversations with clients about timing, because if you have too many people rolling all at the same time, that in itself can cause volatility and stress on liquidity. So people are considering that option now.” 

But the choice to adopt more flexible rolling dates is not only about sentiment – more practical reasons also play a big role.

It wouldn’t surprise me if we see people start thinking about rolling at least a week or two before
Tim Jones, Credit Suisse

The head of European FX and emerging markets sales at a European bank notes that for asset managers, it makes sense to grab liquidity when they can, rather than waiting for the last days of the month when the whole market is trying to do the same thing. 

“It’s a very sensible approach and I could see this being something that’s here to stay. If I was investing money with an asset manager, I would certainly like them to take that approach,” he says. 

The head of trading at a large US asset manager says his firm has been looking at more flexible strategies in order to move trades away from month-end, when quoted and theoretical prices can diverge.

“Moving away from those periods can be very important, especially in more active strategies,” he says.

March madness

Index-tracking asset managers rely on FX swaps to avoid tracking errors arising from currency movements in bond and other portfolios, tweaking the positions and rolling them over each month to coincide with index updates. As index trackers have grown, so has the size of the FX swap business. It now accounts for almost half of the market’s $6.6 trillion in daily turnover, according to the Bank for International Settlements.

The products are not centrally cleared, so although the bulk of trading tends to be in short tenors they can still consume a large amount of financial resources for dealers. That makes it a potentially sensitive business when monthly rolls coincide with quarter-end reporting.

As the end of March approached, asset managers feared they would be unable to secure the liquidity needed to roll their positions efficiently. Concerns were heightened by worries over traders being forced to work from home.  

“Back in March there was a massive scramble for asset managers and real money managers to cover positions far earlier than normal, potentially due to the uncertainty of how markets and liquidity would react with traders hunkered down working from home,” says Credit Suisse’s Jones.

Turbulent trading conditions created the perfect storm, leading some managers to roll their positions earlier than originally planned, securing their funding but increasing the risk of tracking errors. This in turn meant that the quarter-end squeeze was far smaller than expected.

“Many market players waited with bated breath for a couple of days in March expecting some gigantic flows to come through. In fact, it turned out to be somewhat of a damp squib in the end, because a significant amount of these transactions had been done in the two weeks leading up to that,” says the European bank’s sales head.

New normal

The June quarter-end is very different. The FX swap market has normalised in recent weeks, with tight spreads and liquidity back to pre-March levels. Participants attribute this almost exclusively to the Fed’s intervention, which ensured the market had an adequate supply of dollar liquidity. 

However, even given the relatively calm end to the first quarter, and the more familiar market levels seen today, dealers say asset managers are still keen to have conversations about roll timings. 

“The dialogue with asset managers is pretty much constant, as they’re always polling dealers to gauge what liquidity is like and to look at whether they should roll early,” says Adrian Averre, head of FX derivatives electronic trading at BNP Paribas.

The dialogue with asset managers is pretty much constant, as they’re always polling dealers to gauge what liquidity is like and to look at whether they should roll early
Adrian Averre, BNP Paribas

Credit Suisse’s Jones, though, says it might not be long before asset managers revert to their old strategies if this quarter-end proves uneventful.

“If this month goes smoothly, I imagine we might see rolls getting closer to normality in September,” he says. 

Speaking to in mid-March, James Binny, global head of currency at State Street Global Advisors, said he rolled a third of the company’s book early because of concerns around liquidity. But, he says, with things looking better since the Federal Reserve boosted its dollar swap lines with other central banks an early roll might not be necessary.  

“For the moment the situation is fine, whether this is due to the underlying situation being fine or all the liquidity provided by the Fed and others,” he says. “The forward market is functioning efficiently and we are operating normally.” 

However, he remains cautious as the final weeks of Q2 get closer: “We always approach quarter-end with caution, particularly this time given what happened at the end of the previous quarter.” 

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