South Korea's National Pension Service (NPS), which manages up to $88 billion in currency forward limits, lacks a transparent public process for selecting foreign exchange (FX) trading counterparties, according to industry observations reported on May 14. While the pension fund publicly selects securities firms quarterly for domestic and overseas stock and bond transactions, FX swap and currency forward trades are handled through internal team discretion without disclosed selection criteria. The absence of formal counterparty selection procedures has raised concerns about excessive sales competition and potential conflicts of interest in managing one of the foreign exchange market's largest institutional participants.
NPS Foreign Assets Reach $588.2 Billion With Expanded Hedge Limits
According to the financial investment industry on May 14, the NPS Fund Management Headquarters conducts FX swap and currency forward transactions primarily with Seoul branches of foreign banks and select domestic banks. As of March, the pension fund's foreign currency assets totaled $588.2 billion. Under the newly announced foreign exchange new framework strategy, the hedge limit was temporarily expanded to 15%, allowing the NPS to conduct currency forward transactions of up to $88 billion (132.3 trillion won).
If tactical currency hedging (±5%) is included, the total hedge limit can increase to 20%, approximately $117.6 billion (176.4 trillion won). In late February of last year, the pension fund increased its tactical hedge position to $15.064 billion in response to high exchange rates, equivalent to 21.9 trillion won at the exchange rate of 1,459 won at that time.
FX swaps involve exchanging different currencies at the current time point and re-exchanging the principal at a predetermined forward exchange rate after a certain period. Currency forwards are transactions to buy or sell foreign currency at an agreed exchange rate with a counterparty at a specific future time point. These over-the-counter derivative transactions are used by the pension fund to raise overseas investment funds or for currency hedging.
Securities Trading Uses Quarterly Public Selection Process
For domestic stocks and bonds as well as overseas stocks and bonds, the NPS publicly selects securities firms quarterly. In the first quarter of this year, the pension fund disclosed 36 securities firms for domestic stock transactions, 41 for domestic bonds, 8 for overseas stocks, and 67 for overseas bonds.
Securities firms are selected through requirements and evaluations specified by the pension fund. Grades are assigned based on evaluation results covering business processing capabilities, personnel, systems, and operational support services, with minimum transaction volumes allocated accordingly.
However, no counterparty selection process exists for FX swap or currency forward transactions. Industry sources point out that foreign exchange banks and foreign exchange business handling institutions (securities firms) engage in fierce sales competition to secure the pension fund's transaction volume.
The FX Operations Team, which handles the pension fund's foreign exchange operations and foreign exchange exposure management, is known to have considerable discretion in determining trading counterparties, leading to active sales efforts. This structure has been cited as background for repeated controversies over so-called "revolving door" practices, where pension fund alumni are recruited to bring in transaction volume.
Market Participants Cite Concerns Over Discretionary Authority
The National Pension Service maintains that while it operates selection criteria for securities firms handling stocks, bonds, and short-term funds, futures and derivatives are managed according to internal standards with institution-specific limits set by the risk management division head.
Some observers suggest that the pension fund's transaction scale is substantial enough that counterparty institutions capable of handling it may be limited. Others note that if trading plans are disclosed in advance, they could affect market prices, making it difficult to publicly disclose counterparty institutions.
However, counterarguments questioning the sufficiency of explanations for not having a counterparty selection process are substantial. The argument holds that selecting counterparty institutions according to public criteria and then allocating transaction volume through price competition within that framework would ensure both transparency and profitability.
One foreign exchange market participant stated, "The pension fund processes FX transactions through specific institutions or specific sales personnel without established procedures," adding, "While promoting won internationalization, a closed structure remains within the region."
Another participant said, "Almost any major domestic or foreign bank would have adequate (currency forward) limits," noting, "Currently, there is a market perception that the authority of the person in charge plays a significant role due to unclear counterparty selection criteria."
This participant pointed out, "Even though price differences among domestic banks excluding foreign banks are not large, volume distribution is not (equal)."
Another participant stated, "If currency forward maturities are not extended, price differences by institution may not be large," but added, "It may be advantageous for the pension fund to trade with institutions like foreign banks that can quickly provide prices for large volumes or have less market impact." The participant concluded, "Comprehensive consideration of these factors seems necessary to establish counterparty selection criteria."
FAQ
What is the National Pension Service's currency forward transaction limit?
As of March, the NPS manages up to $88 billion in currency forward limits based on its $588.2 billion in foreign currency assets and a temporarily expanded 15% hedge ratio. Including tactical hedging provisions, the total limit can reach approximately $117.6 billion.
How does the NPS select counterparties for stock and bond trading?
The National Pension Service publicly selects securities firms quarterly for domestic and overseas stock and bond transactions. In the first quarter of this year, the fund disclosed 36 firms for domestic stocks, 41 for domestic bonds, 8 for overseas stocks, and 67 for overseas bonds, with selection based on evaluations of business capabilities, personnel, systems, and operational support services.
Why do market participants express concerns about FX trading practices?
Market participants cite the absence of transparent counterparty selection criteria for FX transactions, noting that the FX Operations Team exercises considerable discretion in selecting trading partners. This has raised concerns about excessive sales competition and potential conflicts of interest in managing substantial transaction volumes.
