Eric Huttman, CEO at FX-as-a-Service provider, MillTechFX, outlines how, driven by pressure from investors, governments and consumers, ESG criteria is now central to the decision-making process for many businesses.
According to EY, more than three-quarters of investors think that companies should make investments that address ESG issues relevant to their business, even if it reduces profits in the short term. Likewise, a recent survey from PwC found ESG funds are expected to exceed conventional funds by 2025 – ESG is now a fundamental precept of investing and forms a core component of firms’ operating practices.
However, in the context of the FX market, many of the points of contact with ESG are still evolving. With ESG set to remain a dominant theme in global financial markets, now is the time to examine where this movement has found a footing in FX and the steps that firms can take in enhancing their ESG credentials moving forwards.
ESG in FX
ESG has begun to play an increasingly important role in FX. According to MillTechFX’s ‘2022 fund manager FX survey’, 58% of fund managers said that their FX counterparties must have strong ESG credentials, while 36% said it was an important consideration.
Most of the emphasis to date has been on the first two letters of the acronym – ‘E’ (environmental) and ‘S’ (social), while the ‘G’ (governance) has often been left behind. Strong governance in areas such as regulatory compliance, transparency and implementation of industry best practices must form a central element of any business seeking to be a good corporate citizen.
Fund managers that trade currencies can achieve this through various means. For example, improving the cost, quality and transparency of their FX execution and assessing the ESG credentials of partners and service providers can help in strengthening governance. So, how can firms put these processes in place?
Transparency is key to strong governance
Transparency and strong governance are intrinsically linked. It’s impossible to demonstrate accuracy and accountability to limited partners or shareholders without full visibility across a company’s practices and operations.
Steps that firms can take to improve their transparency and strengthen governance include:
1) Compare the market
At any given time, many corporates and asset managers may not be able to trade at the best available rate, as they often rely on a single bank or broker. This is because they tend to only work with a small number of counterparties for their FX due to the complexity of setting up multiple banking relationships, making it harder to compare prices. As a result, firms may not demonstrate the best execution, meaning they risk failing to fulfil their fiduciary responsibility to their investors. Harnessing technology-driven solutions can help firms gain a more transparent view of the market by enabling them to access rates from multiple banks.
2) Transaction Cost Analysis (TCA)
Cost oversight is central to strong governance. Transaction costs can be hidden in the FX spread, typically calculated as the difference between the traded rate at the point of execution and the mid-market rate at that time. TCA was specifically created to highlight these types of hidden costs and enables firms to understand how much they are being charged for the execution of their FX transactions. Ongoing, quarterly TCA from an independent TCA provider can be embedded as a new operational practice to ensure cost transparency.
3) Adopting the Global FX Code (GFXC)
The BIS Foreign Exchange Working Group published this in 2017 to promote integrity and set out best practices across the wholesale FX market. However, the code is voluntary, and out of the 1,100+ signatories which have registered, there are only 80 asset managers, 30 corporates and 13 pension funds. It’s vital that we promote the code among buy-side firms and corporates as it enables them to scrutinise their liquidity providers and partners’ processes against best practices, ensuring they get the transparency they deserve.
4) Consider ESG credentials of partners
It’s not just a company’s own infrastructure that reflects strong governance but also that of any partner or affiliate organisation. When transacting in FX, firms should seek to use FX providers which adhere to internationally recognised ESG standards, such as the Principles for Responsible Investment (PRI).
A growing priority
As investors become increasingly driven by ESG criteria, industry participants must have the right processes in place to meet this demand. Many firms that trade currencies remain beholden to manual legacy systems that leave them with an opaque view of the market and vulnerable to hidden costs. Harnessing available tools and initiatives could greatly increase market transparency, enabling firms to demonstrate good governance and meet ESG criteria.
