Speaking in Sydney to the board of CLS Bank International, Reserve Bank of Australia deputy governor Andrew Hauser said the sector’s total FX hedge book, currently estimated at around $.5 trillion, could double over the next decade.
Growth, he explained, will be driven by rising super assets – from 150 per cent to 180 per cent of gross domestic product – larger offshore allocations and ageing members seeking more stable returns.
“As super funds’ members age over time, they are likely to demand greater certainty of returns, driving super fund portfolios away from equity and towards fixed income,” he said.
“But FX hedge ratios for foreign currency fixed income assets are typically much higher than those for equities, reflecting the very different shape of asset returns and correlations.”
Hauser stressed that while these changes reflect prudent risk management and would have little effect on the global FX swaps market, which exceeds US$100 trillion, their impact is more significant in the Australian dollar swaps market.
“So it is likely that super funds will have to extend and diversify their pool of hedge providers over time to avoid hitting concentration limits,” Hauser said. “They may also be asked to meet increased margining and collateral requirements on their hedging positions.”
He noted that many funds are already reviewing their liquidity management practices.
One area of focus is ensuring sufficient resources to meet potential short-run liquidity needs, such as higher replacement costs for maturing hedges during periods of Australian dollar weakness.
While these risks are manageable under most scenarios today, Hauser cautioned that they will rise as the hedge book expands.
He also warned that funds rely heavily on continuous access to functioning derivatives markets, since short-term instruments are often used to hedge longer-term exposures.
“If these markets were to become impaired such that rolling these hedges became difficult or prohibitively expensive, as occurred during episodes of US dollar funding stresses in both 2008 and 2020, super funds would either need to sell foreign assets or face unhedged foreign currency exposures for a period, both of which could be undesirable in a period of market volatility.”
Recent data has suggested superannuation funds having already slightly lifted their hedge ratios on international equities, reversing a multi-year downward trend.
According to a report penned by Deutsche Bank’s macro strategist, Lachlan Dynan, hedge ratios increased from 20.6 per cent to 22.2 per cent in the second quarter, signalling an emerging upside risk for the Australian dollar.
Dynan explained that the rise reflects a more dynamic response to recent market signals, rather than adherence to long-term historical averages.
“The moderate rise in hedge ratios in Q2 would suggest super funds have indeed taken some signal from recent correlation changes, rather than leaning purely on longer-term windows,” the strategist said, adding that this move raises the odds further rises will take place over the remainder of the year.
“With correlations remaining in flux in recent months and still notably lower than recent years, this would seem to increase the risk that we continue to see hedge ratio rises through Q3 and Q4, bolstering our view that AUD/USD should reach 0.68 by year-end,” he said.
