Context:The usage of derivatives is bearing some counterparty risk; how does we evaluate that?
Impact for the fund:No impact
The fund uses derivatives for currency hedging purposes only, with no use of derivatives for interest rate or credit risk hedging purposes. For currency hedging – we use a panel of top-tier banks (US G-SIBs) to enter into forward contracts, including State Street – our custodian. For each FX forward trades, collateral is posted which significantly reduces the counterparty credit risk. For forward contracts entered into with State Street, no collateral is exchanged as they are our custodian.
In any case, credit risk of derivatives counterparties is mitigated by the collateral received as well as the high quality of the counterparties. Furthermore, all derivatives counterparties are covered by analysts as part of the investment process and therefore their fundamental credit risk is closely monitored by the investment team which further mitigates the credit risk.
As with the issuers we own in the fund, if there were to be a deterioration of credit quality of our derivatives counterparties, appropriate action would be taken to reduce exposure to these – following our investment process.