Group 17- Analyze the strategy of prudential ad HSBC after the brexit . »

« UK, the most out of favour Region »

About HSBC

As an international bank, its main objective is to be the world’s leading bank and to gain the respect of its customers.  

 

The overall strategy

Our purpose is to be where the growth is, connecting customers to opportunities. We enable businesses to thrive and economies to prosper, helping people fulfil their hopes and dreams and realize their ambitions.

We have developed a long-term strategy that reflects our purpose and distinctive advantages:

  • A network of businesses connecting the world: HSBC is well positioned to capture international trade and capital flows. Our global reach and range of services place us in a strong position to serve clients as they grow from small enterprises into large multinationals
  • Wealth management and retail with local scale: we aim to make the most of opportunities arising from social mobility, wealth creation and long-term demographic changes in our priority growth markets. We will invest in full-scale retail businesses in markets where we can achieve profitable scale

 

After Brexit, Is there any changes in HSBC’s strategies?

Voting for leaving the EU, was with heavy consequences on UK’s economy and especially its banking and financial systems, In a way affecting Institutional equity investors’ choices, they  do not trust anymore the British markets and identify it at a region out of favour in which they won’t put their money.

 

HSBC strategists Robert Parkes and Amit Shrivastava note that globally managed funds have substantially reduced the weightings of their investments in the UK since the June referendum outcome, and are increasingly favouring continental Europe as a place to put their money because of the uncertainty caused by Brexit.

[Source: http://www.businessinsider.fr/us/hsbc-on-brexit-investor-outflows-capital-flight-2016-10/]

 

Post-Brexit: How HSBC managed Risk and Regulations for maintaining the health of its market?

The result of ‘Brexit’ referendum was a shock affecting different markets worldwide, despite polls predicting a knife-edge result. Actually it is quite interesting to look at the steps HSBC provided to manage risks that corporate treasurers can consider.

 

HSBC has experience in following the world’s most significant risk events, and a wealth of expertise, HSBC is proactive in working with customers to define and implement hedging programmes which combine stability and dynamism to reflect changing market conditions.

Treasurers need to have a hedging programme consistent with their internal treasury policy and such policy in turn has to match the underlying business requirement, this varies from sector to sector or from company to company depending on global exposure.

Step one: Hedge ratios and time horizon

Having defined the hedging objectives, the next step treasurers need to decide is the proportion of exposures appropriate for their industry, shareholders’ risk appetite, and the risk management horizon. For instance, a heavy engineering company typically hedges over one to ten years, while a retailer may have a risk management horizon extending from one to six months. Inevitably, the time ‘buckets’ will be quite different in each case, as will the hedge ratio in each ‘bucket’, with most companies choosing to decrease the level of hedging over time depending on the reliability of forecast exposures. For example, a company may choose to hedge 100 per cent of exposures during the following month or quarter, but only 10 or 20 per cent in the sixth month or quarter.

Step two: Hedging approaches

Once the hedge ratio and appropriate time horizon have been determined, treasurers can decide what style of hedging will allow them to meet their risk management needs most precisely. As figure 1 shows, this can be:

 

  • Static (eg hedging for a whole quarter at the start of that quarter)
  • Rolling (eg hedging every month for the corresponding month in the following quarter)
  • Layered (eg hedge one third of each month for the following rolling quarter)
  • Or a combination of all three

 

These strategies tend to produce a significantly smoother outcome compared with hedging on a spot basis, as they are based on the concept of moving averages but this is not guaranteed. In the example given in figure 2, a static approach results in the greatest volatility, with a layered approach resulting in the least volatility.

Figure 1. Static, rolling and layered hedging with impact of different hedging approaches

Figure 2. Impact of different hedge approaches

Source: HSBC Global Markets, August 2016 Bloomberg

Step three: A balanced portfolio

Once the second step has been agreed, the next step is to determine the most appropriate hedging instruments to use for balanced portfolio. When a spot is trading at the middle of its range in a mean reverting currency, there is great uncertainty about the future direction, whereas when it’s at the higher or lower end, it’s more likely to move towards the average. This can influence a treasurer’s choice over the ratio of each instrument to employ, and the tenor of hedging transactions. For example, if spot is trading at unfavourable levels, the treasurer may not want to hedge so much volume or for long term so as to avoid  locking in potentially unfavourable rates. Consequently, they may favour the use of options rather than forwards for a shorter time period.

HSBC works with clients to model different approaches and outcomes, and then  benchmark each strategy with hindsight to determine how successful it was, or would have been.

Figure 3. Analysing hedge scenarios

Scenario 3 (in figure 3 above) is more appropriate when the currency is trading at a long term mean. Dynamically however it can be split on the basis of a multi-year average (30 years in this example) with tenors increasing or decreasing depending on the risk profile.

For instance, assuming a GBP-USD rate of 1.3200, if a client was a buyer of GBP, their fixed hedges are likely to be higher compared with flexible and unhedged positions.

As currency moves in a client’s favour, they would typically increase the hedging tenors to longer dates to enjoy the favourable rate and vice versa (figure 4).

Figure 4. Flexible hedging in practice and balancing flow certainty with currency volatility

HSBC analytics, Bloomberg

Forms of uncertainty

An event-type or one-time exposure needs a different set of solutions compared with the regular hedging that requires a lot of forethought in terms of analysis, prior to engaging into any hedging activities. Using the Brexit referendum as an example, institutions exposed to the affected currency pair risk found themselves balanced on a precipice from which they could be pushed in either direction, resulting in a major gain or significant loss. Hedging such a risk using fixed mechanisms, like forward contracts, removes the opportunity to derive advantage compared with leaving the risk fully open: a simple case of heads or tails, where only one of the said two strategies are likely to win. A flexible option-linked solution on the other hand came at an inflated price compared with times of normal volatility. The only factor potentially providing respite on pricing was the short duration trade, as the time value element post-referendum more or less reflected the uncertainty falling way beyond the result date.

There is no single, right or wrong mechanism to hedge FX, it depends on factors such as the cost of hedging, margins in the underlying business, currency volatility, flow certainty, budgets etc. Regular disciplined hedging, with a mix of different solutions could offer an outcome that provides reduced volatility over a longer time frame.

HSBC has discussed this approach with its clients who have greeted this dynamic, blended approach to hedging very favourably, and in many cases, it is relatively new to some treasurers. Many have upper and lower hedging bands, but they don’t necessarily use a mix of instruments, even though these may be authorised as part of the treasury policy. Witnessing the effect of the Brexit referendum on GBP exchange rates should be a catalyst to test existing policies and approaches, and refine them accordingly. There have rarely been such significant event-risk instances of a liquid currency of a developed country. For many companies, the political, economic and market volatility that is likely to ensue, not only in the UK but more widely, has effectively removed their ability to predict future cash flow, so adopting a flexible, balanced method for managing currency risk has never been so important.

 

About Prudential

 

The United Kingdom’s Brexit vote has major implications for the insurance and financial sectors, considering their investment yields and income are likely to fall due to the pressure on interest rates. Prudential ‘s ( PRU ) stock fell over 7% following the Brexit vote on June 23 amid increased economic uncertainty and fears of falling investment income owing to subdued interest rates and falling yields. However, it has since recovered on expectations of additional stimulus measures by central banks around the world to tide over the Brexit-related decline in trade and money supply.

 

Impact Of Lower Interest Rates

Prudential is expected to generate about 20% of its revenues from investments in the global markets in 2016, totaling about $11 billion.

The risk of persistent lower interest rates will definitely impact this metric, considering fixed maturity securities contributed almost 67% of Prudential’s net investment income in the last two years.

  • Prudential has considerable exposure to fixed maturity securities in the U.S., U.K as well as the rest of Europe. Post-Brexit, the yield on the 10-year U.S. treasury note fell below 1.5% for the first time since 2012, yields on U.K. benchmark government bonds fell below 1% for the first time on record and 10-year government bond yields in Germany ended below 0%. Other developed economies such as France, Sweden, Switzerland and Japan all touched all-time lows.

The fall in investment yields is likely to have a considerable impact on Prudential’s valuation, considering that investments contribute over 20% of the company’s valuation, per our estimates. We expect Prudential’s yield on U.S. retirement assets to decline to around 0.8% by the end of our forecast period. Owing to persistent low interest rates and falling government bond yields, there could be a downside of about 10% to the company’s valuation if its yield on U.S. retirement assets declines to about 0.7%.

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