FAQ

TCX Fund (TCX or the Fund) is a fund whose corporate base and offices are located in Amsterdam, the Netherlands. The fund was established in 2007 by a group of international development finance institutions (DFIs), following an initiative by FMO, the Dutch development bank.

The Fund has a number of investors. These include the German, Dutch, British and Swiss governments, who provided risk capital to facilitate the participation by other investors. The other investors can be divided in a) development finance institutions (DFIs), including FMO from the Netherlands, KfW, DEG and EFSE from Germany, AFD and Proparco from France, BIO from Belgium, OFID from Vienna, JBIC from Japan and Cofides from Spain; b) multilateral development finance institutions including EBRD, based in London, the EIB from Luxembourg, the IFC and the IDB from Washington DC, the AFDB from Tunis/Abidjan and the DBSA from Johannesburg and c) specialized microfinance investment vehicles (MIVs) including Oikocredit, Oxfam-Novib Funds, Triple Jump/ASN Funds, Blue Orchard Microfinance Fund, and Grameen Crédit Agricole Foundation.

The mandate of the Fund is to contribute to better functioning financial markets in developing countries, primarily by developing and making available risk management products like derivatives, for countries and markets where these risk management products are not sufficiently developed. By its nature TCX is, as the majority of its shareholders, a development finance institution.

The Fund is managed by TCX Investment Management Company BV (sometimes called ‘TIM’), a fund management company, based in Amsterdam, whose primary responsibility it is to manage the Fund and to execute the Fund’s developmental mandate.

TCX Fund’s primary function is to hedge, in other words to provide protection against, the exchange rate risk (also called currency risk), that businesses in emerging and developing economies may face when they borrow long term funds from lenders abroad. The Fund itself does not provide funding. It only provides hedging products.

If businesses, banks or projects, borrow long term funds from lenders abroad in US dollars, but earn their revenue in their domestic currency by selling goods and services in the home markets, they will run a currency mismatch and therefore will be exposed to exchange rate risk. Currencies in emerging markets are often very volatile and can suffer sudden and potentially dramatic devaluations. Currency volatility and shocks may result in less stable and less predictable earnings and a growing debt burden in local currency terms. This may result in financial loss and/or in a reduced ability to repay debt and possibly default. Other negative impacts may include distraction from core business, reduced creditworthiness and lower credit ratings, reduced ability to attract debt and, in general, increased instability.

If businesses, banks or projects, borrow long term funds from lenders abroad in US dollars, but earn their revenue in their domestic currency by selling goods and services in the home markets, they will run a currency mismatch and will therefore be exposed to exchange rate risk. Currencies in emerging markets are often very volatile and can suffer sudden and potentially dramatic depreciation and devaluations. Currency volatility and shocks may result in less stable and less predictable earnings and in a growing debt burden in local currency terms. This may result in financial loss and in a reduced ability to repay debt and possibly default. Other negative impacts may include distraction from core business, reduced creditworthiness and lower credit ratings, reduced ability to attract debt and, in general, increased instability.

TCX hedges against exchange rate risk by providing simple risk-mitigation tools, primarily cross-currency forwards and cross-currency swaps, to its shareholders and in some case to the clients of its shareholders. Under a cross-currency swap, TCX effectively commits to compensate its counterparty client for a loss that such counterparty may suffer as a result of the depreciation of the counterparty’s domestic currency against the US dollar or euro.

A bank in a developing country has demand from its SME clients for longer term funding to invest in their businesses, with which they earn revenues in their own local currency. The bank wishes to have matched funding – in the same currency and of equal tenor – to provide the required loans to its SME clients. This required funding cannot be found locally, due a lack of long term bank deposits and due to the absence of a developed long term debt market and local bond markets. Consequently, the bank turns to international DFI lenders. Without access to TCX, the DFI lender might not have been able to provide a loan in the bank’s local currency because of the absence of sufficiently developed hedge markets to cover the exchange rate risk. But, with the existence of TCX, and provided it is a currency and tenor that is effectively covered by TCX, the lender can now provide the required loan to the bank in local currency, while simultaneously hedging the exchange rate risk with TCX. The result is that the lender has credit risk on the borrower only, that the borrowing bank receives a loan of the right tenor and without currency risk and that TCX bears only the exchange rate risk. A more responsible and sustainable financing structure is the end-result.

The end-beneficiaries of TCX services are ultimately borrowers in emerging and developing economies. TCX can transact with its shareholders and other counterparties, allowing them to provide loans in local currency to their clients in emerging and developing economies. It can also transact directly with borrowers. In the latter case, the client has funding in hard currency – generally US dollars or euros – that is hedged by TCX.

TCX hedges exchange rate risk in 70+ different currencies in developing countries. The Fund is active in countries where its shareholders and other counterparties provide funding to their clients and where these clients have demand for local currency. TCX’s current portfolio of hedge transactions is spread across Africa, Asia, Latin America, Eastern Europe and Central Asia. TCX only provides its products if there is no alternative being offered in the market.

Since inception in 2007, TCX has been most heavily utilized by the microfinance industry and by the SME sectors, respectively. Accordingly, the dedicated MIVs that are shareholders in TCX and the DFIs that are active in the financial sector servicing the MFI and SME industry have been the most active users of the Fund. Over the course of the years, infrastructure and sustainable energy have become increasingly important sectors for TCX as well.

In keeping with its mandate of developmental market maker, TCX only operates where there is no functioning, sufficiently liquid, alternative market for its product. Consequently, TCX hedges risk that no other party can take. TCX must therefore absorb the risks it takes on as there is, in general, no market to transfer these risks to. Only in some cases is TCX able to hedge away part of the risk on its balance sheet, by selling part of its portfolio to interested parties. However, TCX relies on currency diversification as its principle risk-mitigation strategy. By combining the local currency loan portfolios of multiple DFI and MIV institutions, TCX achieves a broad and deep diversification into – currently 54 – currencies worldwide. The diversification model significantly reduces the volatility of TCX’s hedge portfolio. Coupled with a very robust and conservative capital structure, TCX boast a very sound risk management structure that has enabled it to sustain severe financial crises, including the severe financial crisis that started in 2008 with the fall of Lehman Brothers.

TCX prices its hedging products to the greatest extent possible on the basis of existing benchmarks that are available in the local markets and interprets and extrapolates those benchmarks to arrive at a pricing that adequately reflects the risks that TCX is set up to take. Local currency hedging rates and corresponding local currency interest rates are generally higher than interest rates in hard currency like the US Dollars. This difference in rates reflects higher inflation rates in the local currency and the expected depreciation of the local currency over time. In principle, factoring in expected future depreciation, a borrower in a developing country should be indifferent from a pricing perspective between USD dollar loans and local currency loans. Other factors that must however be quantified to make a meaningful comparison are, among other things, the absence of all exchange rate risk, the stability in earnings and the improved stability and creditworthiness, when opting for the local currency. From the perspective of TCX fund, it is observed that the TCX pricing model has allowed the Fund to make a modest profit of several percentage points since inception, suggesting that the model has been adequate in pricing the risks that the Fund absorbs.

The Fund has hedged approximately USD 5 billion worth of loans provided to borrowers in emerging markets and developing countries. The volumes hedged have increased year on year and the Fund has realized a modest profit since inception in keeping with its business model. An increasing number of shareholders and, accordingly, an increasing number of shareholder clients, is utilizing the Fund’s services. The Fund is providing hedging services in an increasing number of countries and currencies.

Notably through its achievements in microfinance and SME finance, TCX has made a difference in the forgotten corners of the world. The Fund has enabled borrowers in less developed, illiquid financial markets to obtain responsible financing without unnecessary currency risks. Another, less quantifiable, but important development impact, is the area of financial market development. By providing its hedging services in currencies and for maturities where previously no market existed, TCX has operated as a market maker. Due to the price discovery process involved – as TCX must determine what correct, risk-based, pricing is, in often virgin territory – and the extension of tenors for which TCX offers it hedges, compared to existing markets, markets become more liquid and risk premia are reduced. This also encourage more participants to enter the market – the demonstration effect of successful local currency transactions completed also plays a role here. This is the more fundamental goal of the Fund, to contribute to the development of liquid and sustainable financial markets that can service the needs of local participants and that offer greater access to all.