How Offshore Funds Handle Currency Pegged Assets

Currency pegs can lull investors into a false sense of comfort. The exchange rate barely moves on most days, spreads look tight, and hedging feels optional. Then, every few years, headlines remind us that pegs depend on policy choices, reserves, and market confidence—and that when they wobble, they can move fast. Offshore funds that handle pegged currencies well combine sober risk management with pragmatic operations: clean valuation, hedge programs that match investor needs, and a playbook for stress. This guide distills how experienced managers approach pegged assets and the practical steps that keep NAVs steady when FX regimes are tested.

What a currency peg really means

A peg is a policy commitment to keep a currency at or near a target value against another currency (often the USD) or a basket. Peers often lump pegs together, but the regimes vary:

Hard peg or currency board: The domestic monetary base is backed by foreign reserves. Example: Hong Kong’s HKD operates within a 7.75–7.85 band against USD supported by a currency board.

Conventional peg: A fixed rate with banded or discretionary interventions. Examples: Saudi riyal (SAR) at 3.75/USD; UAE dirham (AED) at 3.6725/USD.

Band or ERM-like regime: A central rate with a narrow band around it. Example: Danish krone (DKK) in ERM II against the euro with a ±2.25% band.

Managed peg/crawl: The central bank guides the currency along a path or basket with periodic adjustments. Example: Onshore Chinese yuan (CNY) uses a managed regime; the offshore yuan (CNH) floats more but is influenced by policy.

The label matters because it drives your choice of hedging instruments, valuation approach, and stress planning. A deliverable, USD-pegged currency (SAR, AED, HKD) behaves very differently from a restricted currency with NDF markets (CNY, some African and Asian pegs) when stress arrives.

Why offshore funds own pegged-currency assets

Most offshore funds are not betting on pegs directly; they end up with peg exposure because they invest in local assets:

Equities listed in Hong Kong priced in HKD, Middle East bonds issued in SAR or AED, Danish covered bonds in DKK.

Private credit to borrowers whose cash flows are in a pegged currency, often with USD-linked revenue.

Real estate and infrastructure in economies that stabilize against USD or EUR to lower funding risk.

Cash management in local currency where operational convenience or withholding-tax outcomes are better.

Some funds do seek alpha around pegs (carry from forward points, relative-value between onshore/offshore markets, or optionality around tail risks). Even then, the operational plumbing is similar: get the valuations right, size hedges thoughtfully, monitor the policy regime, and plan for convertibility and liquidity.

The mechanics: how funds value pegged currencies

Functional currency and translation

Offshore funds typically pick a base currency—often USD—for their books and NAV. Assets denominated in a pegged currency are translated into the base currency at the reporting FX rate. Key practices:

Determine the fund’s functional currency under IFRS or US GAAP. The functional currency drives how FX gains/losses are recognized.

Use consistent daily FX rates (e.g., WM/Refinitiv 4 p.m. London close) applied to all positions for NAV strikes.

Multi-currency share classes require separate NAV per class; each may be hedged to the share class currency.

Even under a peg, translation gains/losses accrue from micro-moves, forward point accrual, and any overlays.

Pricing sources and fixing hierarchy

A robust valuation policy avoids last-minute scrambles:

Primary source: WM/Refinitiv 4 p.m. London fix or Bloomberg WMR FX rates for spot.

Secondary sources: Bloomberg BGN Composite, ICE BFIX, or custodian-provided end-of-day rates.

Fallbacks: Interbank quotes from approved counterparties, prior day rates adjusted by a market proxy.

Illiquid periods: During market holidays or market stress, use prior fix combined with board-approved valuation adjustments if spreads blow out.

Forwards and NDFs are marked using dealer curves, Bloomberg PX Forward pages, and observable basis spreads. Always document your source and time of fix in the NAV pack.

Bid/ask and fair value adjustments

Pegged FX markets can look tight until they are not. Two subtle but helpful practices:

Apply mid-to-bid/ask adjustments for non-symmetric liquidity, particularly for NDFs and options. Your auditor will ask how you deal with wide markets during stress.

Use fair value pricing for local securities when FX markets move after the local equity close. For example, if HKD is steady but US futures signal a sharp equity move, UCITS and many AIFs use a fair value model to reduce stale pricing risk.

Multi-currency share classes and hedge accounting

Share class hedging reduces currency noise for investors subscribing in EUR, GBP, or JPY:

The underlying fund typically keeps USD as base. If the portfolio is mostly USD-linked pegs (HKD, SAR, AED), the share class hedge overlays EURUSD, GBPUSD, etc., not HKDUSD directly.

The hedge ratio should reflect the net exposure in the share class. Avoid over-hedging by considering cash, accruals, and pending subscriptions/redemptions.

ESMA guidance allows share class hedging for UCITS with rules to minimize cross-contamination of P&L between classes, typically with separate sub-ledgers.

This setup isolates the peg risk at the portfolio level, while investor-level currency risk is handled at the class level.

Hedging strategy playbook

There’s no single “right” approach; match the hedge to the fund’s mandate, liquidity, and fee budget.

1) No hedge, rely on the peg

If your base currency is USD and you hold HKD, SAR, or AED assets, unhedged exposure often behaves like USD due to the peg. Pros:

Simple, low transaction costs.

Minimal tracking error vs USD.

Cons:

Forward points and carry are left on the table.

If the peg uses a band (HKD), small mark-to-market moves may still appear; tail risk remains.

This is common in US-dollar base funds investing in Gulf bonds or Hong Kong equities.

2) Static or rolling forwards

Use deliverable forwards for HKD, SAR, AED, and DKK; use NDFs where currencies are restricted (e.g., CNY, some African pegs):

Rolling monthly or quarterly forwards hedge the notional exposure. Execution can be centralized with a currency overlay provider.

Hedge ratio: 80–105% is common. Avoid overshooting 100% to reduce forced unwinds when assets shrink.

Layering: Ladder maturities (e.g., 1/3 rolling monthly, 1/3 two months out, 1/3 three months) to avoid single-day roll risk.

Costs are mostly the forward points, which reflect interest rate differentials. If the domestic rate is lower than USD, you pay points to be short the pegged currency and long USD.

3) Options for tail risk

Options can protect against de-peg scenarios without sacrificing day-to-day carry:

Risk reversals: Buy out-of-the-money calls on USD against the pegged currency and sell puts to cheapen cost. For HKD, skew markets can be thin; size accordingly.

Digitals or barriers: Payout if the peg breaks a certain level. Liquidity can be sporadic and pricing opaque; use sparingly and with tier-1 counterparties.

NDF options: For currencies like CNY, use NDF options to hedge break risk with cash-settled payoffs in USD.

Options give convexity when you need it, but they require disciplined budgeting and mark-to-model scrutiny.

4) Share class hedging done right

Investors in EUR share classes don’t want a peg debate. Keep it clean:

Hedge the share class’ USD exposure, not every underlying currency. Pegged currencies largely map to USD.

Rebalance at set intervals (daily or weekly) with tolerance bands (e.g., ±5%) to limit transaction costs.

Disclose slippage and tracking error expectations to investors upfront.

Hedging costs, carry, and basis

Know your carry:

Forward points reflect short-term rate differentials. Example: If 3-month USD rates sit 50 bp above HKD rates, a 3-month USDHKD forward to sell HKD/buy USD costs roughly 12.5 bps annualized on notional (approximate; consult live curves).

Cross-currency basis can widen under stress, lifting your costs or reducing expected carry.

Execution quality matters. A 2–3 bp improvement per roll scales across large portfolios.

For restricted currencies, NDF curves can embed policy risk premia. That shows up as unusually steep forward points; treat that as a market-implied “peg risk tax.”

When pegs wobble: case studies and stress design

CHF 2015: a peg that wasn’t

The Swiss National Bank removed the EUR/CHF floor in January 2015. EURCHF jumped over 30% intraday. Lessons for offshore funds:

Liquidity can vanish. Bid/ask went from pips to multi-figure. NAVs need valuation adjustments.

Options saved those who owned convexity; rolling forwards offered no protection.

Counterparty risk is real. Some prime brokers and FX shops suffered losses; CSA terms matter.

Hong Kong’s band defenses

HKD trades in a 7.75–7.85 band. In 2018 and 2022, the HKMA defended the weak side multiple times:

Forward points reflected the battles: short-term HKD rates spiked as the HKMA tightened liquidity.

Funds positioned with short-term cash in HKD enjoyed brief positive carry; those with mismatched hedges paid more to roll.

Dislocations were manageable with good liquidity lines and daily monitoring of Aggregate Balance and interbank rates.

HKMA’s foreign reserves have typically hovered around USD 400–450 billion in recent years, providing substantial firepower relative to monetary base—comforting, but not a blank check.

Qatar 2017: offshore vs onshore split

During the diplomatic rift, QAR spot onshore remained pegged while offshore forwards widened dramatically. Implications:

The onshore peg held, but offshore hedging costs spiked. NDF prices captured convertibility anxiety.

NAVs using onshore deliverable spot still showed stability, but the cost of forward hedges and valuation of NDFs increased.

Lesson: Distinguish deliverable exposures (spot convertibility) from hedging instrument pricing (offshore risk premia).

China 2015 and beyond: managed regimes and CNH/CNY basis

The 2015 devaluation and subsequent management reshaped expectations:

CNH can diverge from CNY at times; the basis widens during stress.

NDFs (settled in USD) are the standard hedge tool for offshore funds that cannot access onshore forwards.

When modeling de-pegs, consider policy tools (counter-cyclical factor, fixing bands) and credit conditions.

Designing stress scenarios

Don’t anchor to yesterday’s calm. Build scenarios that capture peg mechanics:

Small band breach: 1–3% move with transient liquidity strain.

Regime shift: 5–10% reset and tighter capital controls.

Shock break: 20–30% gap move with settlement delays (CHF-like).

Run P&L across:

Spot revaluation of assets and hedges.

Forward re-marking and carry shock.

Liquidity effects: wider spreads, collateral calls, and rebalancing costs.

Correlated market moves: local rates, equities, and credit spreads often move with FX stress.

Governance tip: Present these scenarios quarterly to the board with clear triggers and playbook steps.

Liquidity, capital controls, and settlement risk

Deliverable vs non-deliverable markets

Deliverable pegs (HKD, SAR, AED, DKK): You can settle physical currency via standard spot/forward.

NDF regimes: You settle P&L in USD; perfect for currencies with tight controls or convertibility constraints.

For funds, the distinction matters for:

Custody and cash movements during redemptions.

NAV valuation in times of market dislocation.

Availability and pricing of hedges.

Convertibility and trapped cash

Even with pegs, operational frictions can trap cash:

Settlement holidays, sudden compliance checks, or local market closures delay conversions.

Bank limits: Some local banks cap daily conversions or require extra documentation in stress.

Workaround: Maintain multi-bank relationships and a tested playbook to move cash through alternative hubs.

Side pockets are rare for pure currency issues but can be warranted if de-peg leads to capital controls that prevent liquidation of local assets.

Prime brokers, custodians, and counterparty stack

Peg stress is a counterparty stress. Prepare by:

Diversifying FX counterparties under ISDA/CSA with clear eligible collateral and thresholds.

Monitoring PB balance sheet health and FX clearing capacity.

Pre-negotiating NDF and options lines for restricted currencies; you won’t get them on the day you need them.

Margin and collateral

When forwards re-mark against you, margin moves fast:

Model 5–10 standard deviation moves intraday for collateral stress.

Align collateral currency with needs (USD or EUR) to avoid “collateral FX” pile-ups.

Some funds pre-position Treasury bills as eligible collateral to minimize haircut drag.

Regulatory and documentation considerations

Valuation policy: Board-approved, with a source hierarchy, stale price procedures, and treatment of wide markets.

Risk management: UCITS and AIFMD require documented hedging and VaR/commitment approaches. FX derivatives must be linked to risk reduction or efficient portfolio management.

Share class hedging: Follow ESMA’s requirements to prevent P&L leakage between classes; maintain records of hedge allocations and results per class.

Disclosure: Offering documents should describe peg exposure, tail risk, potential for capital controls, and how hedging costs affect returns.

Reporting: Many regulators expect stress testing and liquidity risk reporting. Include peg-break scenarios and resulting margin needs.

Audit trail: Keep trade tickets, independent price verification evidence, and monthly reconciliations of FX exposures and hedges.

The operational playbook: step-by-step

1) Pre-trade setup

Approvals: Ensure your investment policy allows the pegged currency and related derivatives.

Counterparties: Execute ISDAs/CSAs, set limits for spot/forwards/NDFs/options.

Pricing policy: Update FX valuation sources, cut-off times, and fallbacks.

Systems: Confirm your OMS and PMS can handle multi-currency exposures, forward accruals, and share class hedges.

Dashboard: Build monitoring of reserves, forward points, basis spreads, short-term rates, and local credit metrics.

2) Execution and hedge design

Map exposures: Break down by currency, tenor of cash flows, and liquidity.

Choose instruments: Deliverable forwards for HKD/SAR/AED; NDFs for CNY where needed; options for tail coverage.

Size hedges: Start at 80–90% of net exposure to avoid over-hedging; apply laddering.

Trade windows: Use liquid windows around London/New York overlaps. For share class hedges, standardize rebalancing windows.

Cost control: Request quotes from multiple counterparties, capture TCA (transaction cost analysis).

3) Post-trade and NAV

Daily reconciliation: Match FX trades to broker confirmations; verify rates and notional.

Accruals: Book forward points and realized/unrealized P&L correctly. Many NAV errors arise from mis-accrued forwards.

Fair value checks: Adjust for stale prices when FX volatility spikes after local market close.

Share class allocation: Allocate hedge P&L precisely to the hedged class, not the main fund.

4) Month-end, audit, and governance

Independent price verification: Cross-check spot, forward curves, and option vols against third-party sources.

Stress summary: Include peg-break scenarios in the monthly risk pack with updated exposures and costs.

Limit review: Reassess counterparty limits, collateral usage, and forward roll concentrations.

Board reporting: Provide a concise narrative—what changed in hedging costs, any peg regime developments, and action items.

Common mistakes and how to avoid them

Treating pegs as risk-free: Allocate some budget to tail protection or at least stress hedges. Skipping this entirely is a blind spot.

Hedging the wrong thing: A EUR share class holding USD-linked HKD assets should hedge EURUSD, not HKD directly, unless there’s specific HKD risk targeted.

Ignoring forward points: Carry accumulates. Over a year, a few dozen basis points on large notionals are real money.

Over-hedging: Hedging more than 100% creates forced unwinds when assets move or investors redeem.

Single-counterparty dependency: In stress, one counterparty may pull back. Spread your business across at least two to three banks.

Poor cut-off discipline: Inconsistent rate timestamps lead to NAV noise and auditor pushback.

Forgetting settlement calendars: HKD and USD holidays don’t always align. A forward that appears to mature end-of-month may settle next month, skewing cash projections.

No plan for options liquidity: Buying exotics when markets are calm is feasible; not so during stress. Negotiate ISDA annex language and trading lines early.

Practical examples and back-of-envelope math

Example 1: USD-based fund with HKD equities, no share class hedging

Exposure: HKD 500 million in equities; fund base currency USD.

Decision: No hedge. Rationale: HKD within the band, fund reports in USD; exposure behaves USD-like.

Impact: Daily NAV volatility from USDHKD is minimal, dominated by equity moves. Tail risk remains; add a small HKD risk-reversal as insurance if budget allows.

If you chose to hedge anyway with deliverable forwards:

Assume HKD 500 million sell forward vs USD for 3 months.

Forward points: Suppose 3-month points are -10 pips (approx -5 bps annualized; example only). The cost is roughly HKD 50,000 over 3 months pre-transaction costs.

Benefit: Eliminates band noise; cost is small but adds operational overhead.

Example 2: EUR share class hedging for a USD-based fund invested in HKD/SAR

Portfolio: USD base, 80% HKD, 20% SAR instruments.

Investor: EUR share class with €50 million NAV.

Hedge: Sell EUR/buy USD forward equal to the class NAV, rebalanced weekly, tolerance ±5%.

Expected tracking: Residual tracking error 10–30 bps annual from timing and imperfect rebalancing.

Cost: Forward points reflect EURUSD differential; recent years often show positive carry for EUR sellers when USD rates exceed EUR rates (figures change; check current curves).

This keeps investors’ experience clean and avoids micromanaging HKD or SAR in the class.

Example 3: SAR bond portfolio and carry

Portfolio: SAR 1 billion in investment-grade local bonds; base currency USD; duration 3 years.

Hedge: Sell SAR/buy USD monthly forwards for 100% of exposure.

Forward points: If USD short-term rates are 1% higher than SAR equivalents, annualized hedging carry cost approximates 1% of notional, offset partially by higher SAR bond yields.

Risk: If local rates spike to defend the peg, forward points move in your favor for new hedges, but existing bonds may drop in price. Run joint rate/FX stress.

Example 4: CNH exposure with peg-adjacent regime

Position: CNH 300 million corporate bonds; hedged with 3-month USD/CNH NDFs.

Basis risk: CNH bond prices move with local credit and liquidity; NDF reflects offshore policy views. During stress, NDF carry can widen sharply.

Controls: Reduce tenor, add options for tail coverage, and scale exposure to what your collateral and liquidity can realistically support.

Monitoring the health of a peg

Build a dashboard that updates at least weekly, daily in stress:

Foreign reserves: Level and trend. Hong Kong’s reserves around USD 400–450 billion vs monetary base provide cushion; Saudi reserves in the USD 400–500 billion range offer comfort for SAR. Look at import cover and short-term external debt ratios.

Rate differentials: Short-term local vs USD rates. Spikes suggest defense in action.

Forward points and basis: Elevated forward points can signal market-implied stress or funding tightness.

CDS and local bond spreads: Sovereign CDS widening is an early amber light for regime risk.

Equity and property markets: Rapid declines can strain domestic balance sheets and confidence.

Policy communication: Central bank statements, adjustments to bands, and market operations. Silence in stress can be a signal too.

Onshore vs offshore dislocations: Watch CNH vs CNY, and onshore vs offshore forward pricing in Gulf currencies during geopolitical events.

Turn the dashboard into actions: adjust hedge tenors, tighten share class rebalancing bands, or add options when signals cluster.

Stablecoin pegs vs sovereign pegs: same idea, different plumbing

Some funds now hold tokenized treasuries or use stablecoins for liquidity. The “peg” mechanics are not the same:

Backing and transparency: A sovereign peg relies on policy tools and reserves; a stablecoin relies on reserve assets and governance of a private issuer. Attestations and custody arrangements are crucial.

Break risk: For stablecoins, the common risk is de-peg from reserves mismanagement or bank failure, not macro policy. Pricing can gap on exchanges.

Operational handling: If permitted by mandate, treat stablecoin exposure like a credit/counterparty position with FX overlay if required, not purely as cash equivalent.

The takeaway: don’t conflate tight price behavior with the nature of the backstop.

A practical checklist for offshore funds

Policy and governance

Define the currency policy, including pegged currencies and derivatives allowed.

Approve valuation hierarchies, fair value adjustments, and cut-off times.

Establish clear share class hedging rules and documentation.

Counterparties and infrastructure

Execute ISDAs/CSAs with multiple banks; specify eligible collateral and thresholds.

Ensure systems handle deliverable and NDF products, accruals, and P&L attribution.

Hedging and execution

Map exposures and set hedge ratios with laddering.

Pre-arrange options capacity for tail hedges.

Implement TCA and multi-quote discipline.

Liquidity and collateral

Model de-peg scenarios for margin and cash; pre-position eligible collateral.

Diversify cash custody; maintain lines in both base and pegged currencies.

Monitoring and stress

Track reserves, forward points, basis, and CDS.

Run tiered stress scenarios and set triggers for actions.

Reporting and investor communication

Disclose how pegs are handled, hedging costs, and tail risks.

Provide class-level exposure and hedge outcomes in factsheets.

Professional tips from the field

Keep de-peg insurance small but steady. A modest annual budget for out-of-the-money options is easier to defend than scrambling to buy protection during volatility.

Respect bandwidth: Hedging more frequently than your team can reconcile cleanly leads to errors. Weekly rebalancing with tolerance bands is often the sweet spot for share classes.

Harmonize cut-offs: Align FX cut-offs with equity and bond pricing to avoid artificial FX/equity timing noise.

Test your backups: Quarterly, switch to your secondary pricing source for a day internally. Make sure the NAV engine and reporting don’t break.

Time your rolls: For large notionals, break rolls into multiple sessions and counterparties, and avoid major data releases.

Revisit assumptions after policy shifts: When central banks tweak corridors or reserve requirements, update your forward point and stress assumptions immediately.

Bringing it all together

Handling currency-pegged assets is less about guessing central bank intent and more about building a machine that works under almost any regime. Offshore funds that do this well:

Choose consistent, audit-proof valuation and FX cut-offs.

Use hedges that match the investor promise—no more, no less.

Budget for carry and option spend, and measure execution quality.

Watch the right signals and rehearse their response before stress hits.

Keep investors informed about costs, exposures, and the plausible extremes.

When a peg is stable, the machine hums quietly in the background. When stress appears, the same machine protects NAV, preserves liquidity, and buys you time to make good decisions. That’s the edge professional managers can deliver in markets that most think are riskless—right up until they’re not.