How ESG is influencing FX trading decisions for Asset Managers

1. How are ESG criteria becoming strong factors in FX trading decisions?

Carlo: ESG criteria have become an essential component of the overall investment process for many asset managers. Increasingly, asset managers are assessing the ESG performance of currencies, taking into account the countries’ (of the currencies in consideration) environmental impact, social equality, and governance practices of the countries involved. Countries that are deemed to adopt stronger and more transparent ESG practices tend to see their currencies in higher demand.

Conversely, currencies associated with countries with higher ESG risks may be avoided by asset managers, who opt for reduced exposure to countries with poor environmental practices or governance issues.

We think that progressively this trend will help to encourage more countries to increase their ESG commitments in order to place their currencies in more favorable light.

2. What trend do you observe when it comes to asset managers that are screening currencies?

To align with sustainability goals, asset managers may screen currencies according to their ESG metrics. As a result, we are hearing from more and more of our clients that countries with stronger ESG practices are likely to see an increased demand for their currencies in FX portfolios.

3. Can you tell us more about what asset managers are specifically keeping track of?

ESG-related trends and events, including regulatory changes, sustainability initiatives, and social movements, can influence currency volatility. Asset managers track these developments to assess the potential impact on FX markets.

4. Can the bias from asset managers in turn spur positive ESG practices?

Yes, absolutely. We think that responsible investment-focused asset managers can, in turn use their influence to encourage positive ESG practices. These engagements may likely extend to currency markets, where managers advocate for the adoption of sustainable policies and practices.

5. How are other ESG-linked financial instruments influencing the FX market?

Asset managers exploring ESG-linked financial instruments, such as green bonds or sustainability-linked instruments, may find that their FX trading decisions are influenced by these products.

As derivative products tied to ESG factors continue to develop in the financial market, FX products are also seeing a similar trend. These products involve two parties agreeing on specific ESG key performance indicators (KPIs), with the client being able to earn benefits such as reduced hedging costs or cash rebates if they meet these KPIs assessed annually by an independent auditor. This creates a loyalty scheme where the client’s adherence to ESG goals is rewarded with financial benefits in their FX hedging business. Overall, this incentivises responsible and sustainable practices among asset managers in their FX trading strategies.

6. ESG is as important as the transparent reporting of it.

Yes, when it comes to prioritising investments in currencies from countries with relatively stronger ESG reporting practices, real money asset managers that are committed to ESG principles can also rely on transparency as a positive factor in their decision-making process.

7. On a macro level, what do asset managers also consider?

Asset managers now take climate risks (such as global warming) and other vulnerabilities into account when making FX trading decisions. They may evaluate how currency values could be affected by climate-related events and long-term trends.

Here, there are two main areas that cause the most implications:

(i)   The greening of public and private sector assets / transition of energy generation to greener sources

The greening of public and private sector assets is part of a broader trend towards responsible and sustainable investing. One key development is seen in the growing demand for electric vehicles that has led to a surge in demand for materials like nickel and cobalt, essential elements for the cars’ batteries. This trend is expected to continue as more countries and companies commit to reducing their carbon footprint.

(ii)  Macro and major events that impact many countries at the same time.

The conflict in Ukraine has brought about increased focus on commodities needed for this transition, as well as their suppliers. This includes demand for materials like aluminium, cobalt, copper, lithium, nickel, and silver, which will likely provide long-term support for the currencies of their main exporters.

8. What is one other factor that you think is important to consider?

I think that would have to be stakeholder alignment. It is important for asset managers to align their FX trading approaches with the preferences and expectations of their stakeholders, such as clients, pension funds, and other ESG-driven investors. By understanding and adopting mutually agreed ESG considerations into their FX trading strategies, asset managers potentially play a larger role in contributing to a more sustainable and accountable financial future.