Small and medium-sized enterprises (SMEs) are generally more optimistic about the travails of the currency markets next year. However, according to AFEX’s second annual Currency Risk Outlook, they also consider currency risk at the most significant challenge they face working in a global market. Right now, only 64 percent of SMEs use hedging to mitigate their FX exposures. With many of these companies planning to increase their overseas presence, a greater use of hedging tools is to be expected.
The intent to increase hedging activities is strongest in economies that suffered the greatest level of volatility, like Australia and Canada. Nearly 40 percent of Australian multinationals told AFEX that they intend to expand their hedging programs, compared to nearly 20 percent in the U.S., where hedging is already more common.
AFP spoked with companies about their hedging policies and found that one of the rising forms of hedging relates to hedging the translation of foreign profits. While that still includes a minority of multinationals (translation hedging is barred under FAS 133), more are finding ways to tackle this risk.
The focus on earnings occurs after someone experiences a loss, according to Robert Baer, application specialist in derivatives and hedge accounting at Bloomberg. “In my experience, many companies don’t have an articulated strategy on how to deal with this exposure,” he said. “They pay attention when they report a significant loss.”
According to Baer, very few companies have a policy about hedging net income—primarily because the practice is prohibited under FASB Topic 815 (successor to FAS 133), Derivatives and Hedging. “The reluctance to hedge is primarily driven by the lack of hedge accounting treatment,” Baer said. “I certainly see a lot more attention being paid to it this year,” said Baer. “People are hurting,” he added.
According to a Corporate Treasurers’ Council (CTC) Executive Perspective, there are six ways treasury departments can hedge that illusive risk.
- Understand and quantify the exposure.
- Hedge intercompany transactions that are denominated in a currency other than the functional currency of the entity.
- Selectively hedge cash flow risk. Sometimes converting non-functional cash flow exposure into local currency actually increases the company’s net exposure to FX in the aggregate.
- Hedge nonfunctional currency expenses.
- As a natural hedge, companies can adjust their supply chain partners and choose supply partners that do not pose significant FX risk.
- Finally, set up a dollar functional rebilling entity to help centralize multicurrency risk.