The FX Consortium has been founded by a group of leading players in the US microfinance industry to provide a “Foreign Exchange Risk Mitigation Service”. Its aim is to help microfinance institutions (MFIs) that want to use complex financial processes, such as hedging, to manage their hard currency foreign debt obligations.
The founders of the scheme and members of the steering committee which will oversee the project during its infancy are: Microrate, a rating agency dedicated to the evaluation of microfinance institutions; Global Partnerships, a non-profit microfinance vehicle with over USD 10 million in fund assets; Linkwell Capital; ACCION International, a global non-profit organisation that supports MFIs that has a portfolio of USD 2 billion; Calvert Foundation, a non-profit microfinance vehicle with over USD 80 million in fund assets; and Calmeadow, a Canadian firm that helps run and finance two microfinance funds, ProFund Internacional, worth USD 22 million that invests in Latin America and AfriCap Microfinance Fund, worth USD 15 million that focuses on Africa.
The largest sources of non-donor foreign capital to local MFIs are generally denominated in hard currencies such as the US dollar and Euro. This is likely increase as MFI demand grows and new funding comes from international financial institutions (IFIs) and Microfinance Investments Vehicles (MIVs), rather than donor organisations.
However, foreign capital exposes MFIs to a foreign exchange rate risk, as MFIs use the funding to make loans to clients in the local currency. The repayment of the hard currency denominated foreign capital could be significantly more expensive to the MFIs relative to a local currency if the local currency devalues, resulting in high interest rates to their clients. As MFIs primarily operate in developing countries, the risk of local currency devaluation can be higher than in developed nations.
As a result an increasing number of MFIs are looking towards implementing hedging strategies to mitigate the foreign exchange risk. Hedging involves arranging some form of insurance to minimize or eliminate losses from adverse movements in foreign exchange rates and there are a variety of strategies that can be used. For example, currency can be bought in advance at a fixed price for future delivery to protect against the uncertainty in exchange rate movements.
Access and use of foreign exchange hedging instruments has the potential to unlock far greater amounts of commercial funding for the microfinance industry, vital for it be seen as a credible alternative asset class.
The Consortium’s role will be to aggregate the hedging needs of its MFI stakeholders and to organise a hedging service that provides a financial or possibly risk enhancement guarantee. During the next six months, while the project is being established, the Consortium aims to develop a workable business model, raise USD 10-20 million in funding and establish itself as an investment grade legal entity.
Amy Rennison, MicroCapital writer
Additional Sources:
Microfinance Gateway:
http://microfinancegateway.org/content/jobs/
United Nations Capital Development Fund
http://www.uncdf.org/english/microfinance/pubs/newsletter/pages/2005_05/news_managing.php
ACCION International:
www.accion.org/insight/IS16EN.pdf
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