South Korea's NPS Extends FX Hedging, Won Rises on Flexibility Push

South Korea's National Pension Service Shifts to Flexible FX Hedging

South Korea's National Pension Service (NPS) has announced a shift to a more flexible approach for its strategic foreign-exchange (FX) hedging program. The decision, made public on Monday, allows the fund to adjust its hedging strategy in response to evolving market conditions. The NPS extended its hedging duration through 2026, signaling a long-term commitment to managing currency risks according to Bloomberg.

The move comes as the Korean won has struggled against the U.S. dollar, reaching a 16-year low in recent months. The NPS has taken tactical steps to stabilize the currency, including selling U.S. dollars in the market. These actions are part of a broader effort to limit the won's depreciation amid ongoing trade uncertainties and capital outflows as reported by Bloomberg.

In a related development, the Bank of Korea (BOK) and the NPS have extended their foreign exchange swap agreement through the end of 2026. The agreement allows the pension fund to borrow dollars from the central bank's reserves, easing upward pressure on the U.S. dollar and providing support to the won. The won responded positively to the news, rising more than 0.7% against the dollar.

A Flexible Hedging Strategy

The NPS's new approach emphasizes adaptability, allowing it to respond more effectively to volatile market conditions. The fund had previously maintained a rigid hedging formula, but Governor Rhee Chang Yong recently criticized the predictability of the strategy, urging for greater strategic ambiguity. The committee overseeing the NPS's investments has now decided to implement flexible measures, ensuring the fund can act swiftly in unpredictable markets according to Bloomberg.

The hedging ratio—the percentage of overseas assets used to hedge against currency movements—will remain at a maximum of 10% through 2026. This ceiling ensures that the NPS maintains sufficient flexibility without overcommitting to hedging activities that could limit returns. The decision to hold the ratio steady reflects concerns over the prolonged weakness of the won and the need to stabilize the currency according to Reuters.

Market Response and Future Uncertainties

Markets welcomed the news with a sharp rebound in the won. After the announcement, the Korean currency rose to 1,466.5 per dollar, a 0.71% increase. Traders noted that the NPS could activate its hedging measures if the won moves further away from its long-term average, estimated at around 1,475–1,485 per dollar.

The immediate market reaction suggests that investors view the NPS and BOK's coordinated efforts as credible tools for supporting the won according to Channel News Asia.

However, the future remains uncertain. Market participants are closely watching for any changes to the hedging framework. A new consultative group is currently discussing a "new framework" to balance investment returns with currency stability. This initiative could reshape how the NPS manages its FX exposures in the coming years.

Policy Implications and Investor Takeaways

For investors, the NPS's actions highlight South Korea's commitment to maintaining currency stability despite external pressures. The pension fund's large overseas portfolio—$542 billion as of end-September—gives it significant influence in FX markets. By using its assets to stabilize the won, the NPS is also protecting its own returns, as a weaker currency can reduce the value of its dollar-denominated investments according to Bloomberg.

The NPS employs two types of hedging strategies: strategic and tactical. Strategic hedging involves longer-term actions, while tactical hedging allows for more immediate market interventions. The distinction provides the fund with a layered approach to managing FX risk, especially when the won moves toward extremes as explained by a financial glossary.

The extension of the currency swap agreement also underscores the importance of coordination between the BOK and the NPS. This partnership is crucial in managing the won's volatility, particularly as South Korea faces ongoing economic headwinds. The swap line provides a safety net for the NPS while limiting the need for more aggressive interventions in the currency market according to Reuters.