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Going Global: 5 Ways Treasury Can Mitigate FX Volatility

  • By Helen Kane
  • Published: 8/27/2015
passportInitial international expansion is a significant step in the evolution of any business. It represents the opening of new markets—and the game-changing potential of accessing fresh revenue streams.

But going international is not a process without potential pitfalls for treasury. The most striking of these—especially in the current environment—centers on currency volatility. It is extremely difficult for firms to be competitive overseas selling only in U.S. currency—and it is essentially impossible to conduct operations in foreign countries without FX payables (payroll, professional services, leases, etc.). That means every company doing business internationally has at least some exposure to foreign currency risk —and often, quite a bit.

It is critical, then, that treasury and other stakeholders across the enterprise begin making plans to account for FX operations and related exposures as soon as the decision to expand internationally is made. The actionable results of these plans take many forms, but all FX-related efforts ultimately have one goal: mitigating the effect that currency fluctuations—even extreme swings—can have on the bottom line, operations and the confidence of investors.

Ensure cross-departmental communication.

Reducing exposure to foreign currency risk is not just a matter for treasury. The task—and the benefits of its successful completion—touch nearly all areas of the enterprise: sales, purchasing, accounting, FP&A, tax and more. The more departments work together, the more effective the ultimate risk management strategy will be.

Foreign currency hedging, in particular, requires a heavy dose of cross-departmental cooperation. It is critical that treasury work with FP&A to understand potential currency inflows and outflows, as well as their timing. This improves the effectiveness of an FX hedging program by allowing the firm to match the timing and nature of derivatives to future cash flow events, reducing noise and uncertainty caused by daily currency movements. In addition, communicating risk management goals and results with management early and often improves program credibility, enhancing the ability of treasury to further insulate the firm from FX movement via the use of more complex methods.

Find an experienced partner.

It’s the rare treasury department that has the internal expertise to efficiently and effectively “sell” management on a hedging-based FX risk mitigation strategy, educate other departments, set up the program, measure and maintain its effectiveness, and grow it over time. Doing all this is particularly difficult given the myriad responsibilities treasury professionals own in this era of doing more with less.

Instead of further burdening existing personnel (and potentially pushing them outside their core competencies), it’s a great idea to find a third-party consultant whose only job is helping companies reduce FX volatility through hedging. Such an engagement typically results in a faster program rollout, increased credibility throughout the enterprise and improved long-term results.

Leverage technology.

A modern, cloud-based hedge program management software suite can serve as the lynchpin of a company’s FX risk mitigation strategy. The best examples of such solutions dramatically simplify cross-departmental information exchange, unify disparate systems (including enterprise resource planning software and trade portals), allow for a high degree of visibility into program key performance indicators and metrics, and apply necessary controls to help ensure compliant derivative accounting practices.

In addition, hedge program management software simplifies the implementation of a new FX hedge program by facilitating the training and education of treasury and accounting personnel, as well as providing a robust control structure for the new set of processes.

Understand overseas entities’ functional currencies.

Keen attention must be paid to the election of a functional currency—defined by the Financial Accounting Standards Board (FASB) as the “primary currency in which the entity conducts its business”—of overseas subsidiaries, divisions, branches or joint ventures. Many a company has overlooked the implications of this election on their long-term financial reporting. This pivotal decision determines what companies will consider a risk:  intercompany sales/purchases or third-party sales and receivables; U.S. dollar cash or foreign cash. The determination will have a significant impact on the predictability of earnings for companies with deferred revenues in foreign operations. In addition, the opportunities for hedging (and consequent reduction of FX risk) vary significantly depending on whether the entity is local or dollar functional.  

Avoid tying yourself to daily rates.

Companies new to international operations generally need to avoid the siren song of daily rates. The practice generally results in a mismatch in the rates used to record revenues (daily rates) and costs (end-of-month rate), and frequently delivers an unexplainable translation rate in net income.

Unless you are a bank, stick to the practice employed by the largest companies and use a single rate (either the prior month balance sheet rate or an average for the month, which requires recasting) to record activity during the month. This methodology meets the FASB requirement to deliver an appropriately weighted average rate as you report quarterly and year-to-date activity.

Helen Kane is president of Hedge Trackers.

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