Heightened volatility in global markets means companies involved in multicurrency transactions must be extremely diligent about managing their exchange rate exposure. An unexpected market swing can massively impact a corporate balance sheet. FX management involves more than simply hedging against risk; all levels of the organization must be informed and involved to take appropriate action.
We analyzed in detail the issues unique to different departments, discussing some of the strategies and practices that may be implemented to mitigate FX risk.
CFOs work with CEOs to create risk frameworks and direct strategies to treasury executives. The success of risk frameworks relies on the identification of weaknesses, both internally and externally. Yet because of the unstable nature of FX rates, volatility and hedging, corporations struggle to spot risks. According to Deloitte’s 2016 Global FX survey, 56 percent of respondents reported a lack of visibility and reliability of FX forecasts as the biggest challenges in managing FX risk.
1. Make cost efficiency as important as success. Overbought trades or rapidly declining currencies can turn hedges from a protective to punitive measure. Netting hedges and sizing hedge contracts so that they realistically align with forecasted sales are two ways of reducing costs.
2. Ensure that a detailed operational framework exists. The IMF has touted the need for corporations to have a strategy that clearly defines how multicurrency risk exposure is identified, measured and hedged. Teams rely on the CFO for clear delineation of responsibilities and hedging strategies.
3. Have open communication with the board. Beyond healthy collaboration with the CEO, a risk oversight committee can ensure buy-in on operational frameworks from the board of directors. It also provides a forum for CFOs to champion initiatives that will empower treasury teams.
FX risk management attracts more resources than any other corporate treasury responsibility, as illustrated by PWC’s 2014 Global Treasury Survey. Yet, while treasurers benefit from having a variety of tools to manage risk, the uncertainty ahead needs a more methodical approach.
1. Restrain trigger fingers. Market sensitivity to economic data has reached new heights—minor events lead to disproportionately big moves. Large swings tempt specialists to take risks reactively, but specialists make better medium-term decisions if they wait to execute once markets stabilize.
2. Keep your plan global and knowledge local. Each country has its own nuances and vulnerabilities. Trying to act against each market in a tailored fashion creates headaches. A consistent global approach to FX risk management enables specialists to be nimble with local exposure while maintaining consistency.
3. Prepare for the unexpected. A year ago, the terms “Brexit” and “Trump Administration” drew snickers—not anymore. One of treasury’s best tools is forecasting—and there are few political and economic possibilities that aren’t worth running analyses against. Spending time modeling how certain events, and amalgamations of events, can affect credit ratios, dividend flows, product demand, etc. will help specialists execute proactively.
Concerning forecasting cash flows, 2017 looks similar to 2006. Despite the proliferation of automation, spreadsheets and manual processes persist. A 2011 poll from McKinsey found that half the companies with less than $10 billion in revenue still use spreadsheets as their treasury management systems.
Even modernized businesses are challenged. Half the treasurers polled by McKinsey said their forecasting is less than 80 percent accurate. Forecasting challenges are exacerbated by market volatility and international expansion, which press analysts to forecast in near real time. Here are some tactics to combat these challenges.
1. Communicate with local subsidiaries. Open communication with operations in each country provides timely information on factors that affect forecasting. Each country does business differently—identifying whether companies in specific geographies pay invoices within 30 or 60 days is essential. Local staff also disseminates favorable liquidity facilities.2. Utilize automated data inputs. As problematic as spreadsheets are, some CFOs at smaller corporations can’t justify the expense of a fully automated system. Nonetheless, automated FX rate feeds ensure that data used in spreadsheets is accurate. Automated rate feeds cost a fraction of a full system, and allow forecasters to focus energy elsewhere.
3. Run scenarios. If a major market event happened today, corporations would still have access to cash—but not for long. Running liquidity and stress tests in economic peacetime will prepare forecasters for the next surprise event.
4. Continuously monitor liquidity facilities. Many treasurers are not aware of the full breadth of bank accounts, cash reserves, and credit lines their company has across the world. Up-to-date knowledge of statuses and viabilities of these facilities help forecasters access cash quicker in a liquidity crunch and avoid excessive borrowing and tax costs.
Natasha Lala is managing director with OANDA.