Stronger FX Hedging Strategies: a Pandemic Game-changer

As the pandemic continues to throw markets into confusion, forcing corporates to battle against unprecedented volatility, treasury functions have an opportunity, albeit uninvited, to prove their strategic value – especially in relation to FX risk management.

The FX Hedging Strategies for a Post-Covid-19 World survey, carried out jointly between Kantox and TMI, brings this opportunity into sharp focus. It casts light on the levels of preparedness to tackle FX risk among more than 150 respondents drawn from a broad range of sectors and business sizes.

The results indicate that while some have a fairly robust existing approach to FX risk, the world is changing faster than most of us ever expected – and some corporates are not yet well positioned to catch up. The good news is that FX risk management can be enhanced considerably. But first, let’s set the scene for progress with a look at some of the survey’s key findings and trends.

Corporate concerns

Asked about their FX hedging challenges during the past three months of the Covid-19, 68% cited exposure collection and monitoring as their biggest concern. This is a problem typically forced by a lack of system integrity and clearly defined processes, both issues amplified by the pandemic. When it comes to actual FX pain points experienced during the pandemic, 64% said increased volatility was the leading worry.

Some 66% base their cash flow hedging programmes on forecasts. With forecasting accuracy thrown into confusion by sudden revenue volatilities caused by lockdowns, the pandemic has found a weak point. Perhaps resulting from lack of process clarity or data accessibility (or both), 34% of respondents admitted to being over-hedged at some point. Companies seem to be suffering from a lack of confidence in the capacity of their current FX policy and hedging programmes to be effective in times of stress.

Indeed, the survey finds 52% of respondents describing their hedging programmes as either inadequate, partially adequate or non-defined. When anecdotal evidence reveals some policies offering little more advice than ‘do not speculate’, the lack of specificity around even risk tolerance makes the treasurer’s job unnecessarily challenging, even at the best of times.

It’s encouraging to see that 43% see current circumstances as the catalyst for review of their FX management objectives. Some 56% suggest even that FX risk management will increase in importance, post-pandemic.

However, with 81% seeing a future of more work and fewer resources, it was surprising that ‘only’ 56% of respondents are expecting an increase in their workload over the next six months. For those for whom this proves a harsh reality, automation technology can bridge the gap and even enable greater focus on value-adding tasks.

But with 53% of respondents citing lack of technology budget as a hindrance to effective treasury, a business case is needed for the strategic value of robust FX risk management. This should not just talk about reducing time spent on activities such as collecting and monitoring FX exposures, but also highlight the reduction of FX risks and costs faced by organisations in dealing with buyers and suppliers in these most volatile of times. A key starting point for stronger FX management is an effective hedging policy.

Building the right FX hedging policy

The kind of high-level FX hedging policy referred to above (‘do not speculate’) is of minimal use at any point in time. For any business subject to cross-currency transactions (including debt denominated in other currencies), taking time to develop a robust FX policy will help prevent emotionally driven decisions – or decisions not linked to corporate strategy and the way the business operates.

An intelligent FX hedging policy can enable a business to safely buy and sell in local currencies while safeguarding its margins. It also demonstrates good governance to investors and other stakeholders such as banks, ratings agencies and potential mergers and acquisitions (M&A) partners.

Every hedging policy needs to be built around the business and its current needs, not around how the market appears to be behaving. While detail-richness is important when prescribing the FX workflow, the document needs to be both usable and flexible. Usable because if it’s too detailed it becomes a burden, and flexible because it must allow for a rapid response to changing conditions, such as the digital expansion of the business into new territories.

Although by no means comprehensive, the following is a simple guide to FX policy creation:

  • Define strategy. What are you trying to achieve? This goal should evolve as the business evolves. Start with the biggest risks first, test and refine, and then move lower down. A senior-level champion, such as the CFO, is needed to ensure buy-in across the organisation.

  • Identify FX exposures. Separate parts of your business may well be buying and selling the same currency independently of one another. Look at what is going on all around the organisation, involve the supply chain manager and sales department in these conversations, and centralise the risk. Adopting a holistic approach to currency trading enables you to buy and sell a smaller volume of currency and save on costs.

  • Quantify risk. Calculate the volume of exposure and the volatility of the currencies to which those exposures relate.

  • Set up an FX program. Determine and implement the best way of hedging (e.g. based on forecasts; balance-sheet or firm commitments) according your business characteristics (e.g. your pricing or your forecast reliability).

  • Define your FX workflow. Describe, in detail, the steps and the tools you are going to use to implement your policy. Since currency management is a data-driven activity, having the right technology is crucial to reduce manual workload while achieving and tracking the intended results.

  • Allocate responsibilities. This should include not just overall responsibility for policy implementation/policing but also those who are authorised to trade, and any limits.

  • Communicate policy. To mitigate sudden and material market movement risk, it will be necessary for functions such as sales and procurement to be familiar with the policy, and for them to communicate all major transactions to allow pricing adjustments or hedging to be deployed.

  • Review and revise. The nature of the business and its trading cycles will inform frequency, but the need is to check that the policy remains fit for purpose and that it is mitigating risk but not stifling trade nor opportunities, nor costing too much.

Read the full survey report and results >

 

Eleanor Hill

Editor, Treasury Management International (TMI)

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