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Extended Statistic on Currency Exposure and Hedging
Today Danmarks Nationalbank publishes an extended statistic on insurance and pension companies’ currency exposure and hedging. As something new, the statistic now features the hedging between two foreign currencies. This is partly because several companies increasingly hedge dollars to kroner in two steps: first from dollars to euros, and then, to some extent, from euros to kroner. The statistic shows that about 70 per cent of the dollar exposure is hedged, either to euros or kroner, and that about 40 per cent of the euro exposure is hedged to kroner.
Chart 1: Approximately 70 pct. of dollar exposures are hedged, largely to euros and kroner
Note:
Insurance and pension companies’ dollar exposure and hedging to kroner, euro, and other currencies.
Source:
Danmarks Nationalbank (DNFPVALE)
Pension assets and exchange rate risks
Danish insurance and pension companies manage pension assets of approximately DKK 5,200 billion. Approximately half of the assets are invested in Danish securities and assets. The other half of the pension assets consist of foreign stocks, bonds, and other assets denominated in dollars, euros, and other currencies.
The investment in foreign assets exposes the pension companies to exchange rate risks. These are risks that insurance and pension companies can hedge against. This typically occurs through a derivative contract, where a pension company and a bank agree to exchange e.g. kroner and dollars at a predetermined rate at a future point in time.
Dollar exposure is largely hedged to euro
Danish insurance and pension companies have a dollar exposure of approximately DKK 1.5 trillion, which predominantly consists of American bonds, stocks, and other assets denominated in dollars. Of this, companies hedge around DKK 1 trillion to other currencies, especially euros and kroner.
Nearly 70 per cent of the dollar exposure is thus hedged, as shown in Figure 1. Hedging of currency exposures depends on various factors, including the price of derivative contracts and risk management within individual insurance and pension companies.
Dollars are primarily hedged to euros (70 pct.) and kroner (29 pct.). A small portion (1 pct.) of the dollar exposure is hedged to other currencies, such as British pounds and Japanese yen. Insurance and pension companies increasingly hedge dollar exposure to euros, partly due to the high liquidity in the dollar-euro derivatives market. Additionally, the currency risk of euros is considered hedged due to the fixed exchange rate policy. As a result, the companies’ euro exposure has increased.
Chart 2: Approximately 40 pct. of euro exposures are hedged, largely to kroner
Note:
The total euro exposure and hedging of insurance and pension companies to Danish kroner, other currencies, and the dollar are significant factors in the foreign exchange market. Notably, a substantial portion of the euro exposure is derived from hedging dollar exposure to euro.
Source:
Danmarks Nationalbank (DNFPVALE)
Insurance and pension companies have a combined euro exposure of approximately DKK 1.775 trillion, as shown in Figure 2. About half of the euro exposure stems from companies’ hedge of dollars and other currencies to euros, while the other half is related to the companies’ holdings of bonds and stocks denominated in euros. Of the total euro exposure, approximately DKK 665 billion is hedged to kroner. This corresponds to a hedge ratio of nearly 40 per cent, with a portion related to the hedging of dollars via euros to kroner, as described in Box 1.
BOX 1
The extended statistic for the insurance and pension sector’s currency exposure and hedging
The statistic on currency exposure and hedging has been expanded as of April 2024 to provide a more comprehensive description of currency risks in the insurance and pension sector. This change is partly due to the increasing trend of insurance and pension companies hedging towards the euro.
Insurance and pension companies report their exposure from assets denominated in currencies other than the Danish krone monthly, along with the amount of exposure that is hedged to other currencies. Nationalbanken calculates the sector’s total currency exposure and hedging based on this data.
In the extended statistic, currency exposures and hedges are broken down by the US dollar, euro, and other currencies. Currency exposure is primarily derived from assets denominated in foreign currencies on pension companies’ balance sheet. Additionally, currency exposure can arise from currency hedging itself. For euro exposure, this typically involves derivative contracts where dollars are hedged to euros. In March 2024, companies hedged dollars to euros for DKK 699.2 billion, contributing to the sector’s euro exposure of DKK 1,773.7 billion (see Table A below). The total euro exposure consists of both the dollar hedge (DKK 699.2 billion) and hedge of other currencies (DKK 182.5 billion). The remaining currency exposure of DKK 892.0 billion originates from euro-denominated assets on companies’ balance sheets (i.e., 892.0 = 1,773.7 - 699.2 - 182.5).
The significant difference between the previous and expanded statistic lies precisely in the inclusion of derived currency exposures and hedges between two foreign currencies—primarily between the dollar and the euro—in the sector’s overall exposure and hedging. The previous statistic primarily focused on linking currency exposure from companies’ balance sheet assets with their corresponding hedges. In the example provided in Table A, the dollar hedge to the euro at DKK 699.2 billion was not fully accounted for in the sector’s euro exposure, resulting in an underestimation of both the euro exposure and the subsequent hedge to Danish kroner.
With the expanded statistic, consideration is given to the fact that currency hedging can occur across multiple currencies. For dollar hedging, the expanded statistic has minimal impact. Approximately 70 per cent of dollar exposure is hedged to other currencies. However, the sector’s euro exposure and hedging increases in the new statistic, as this revised approach accounts for the portion of exposure from other currencies that is hedged to the euro.
Table A
Currency exposure and hedging of the insurance and pension sector by currency, March 2024
|
Billion kroner |
Euro |
Dollar |
Other currencies |
|
Total currency exposure |
1,773.7 | 1,555.4 | 473.2 |
|
Hedged currency exposure |
676.2 | 998.3 | 259.2 |
|
- Hedged to Kroner |
664.3 | 292.1 | 46.7 |
|
- Hedged to Euro |
- | 699.2 | 182.5 |
|
- Hedged to Dollar |
0.0 | - | 30.0 |
|
- Hedged to other currencies |
11.9 | 7.0 | - |
|
Unhedged currency exposure |
1,097.5 | 557.1 | 214.0 |
Source:
Danmarks Nationalbank (DNFPVALE)