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Performing a holistic review of your operational FX hedging program

Date:
March 29, 2021
  • amanda breslin headshot

    Authors

    Amanda Breslin

    Managing Director
    Treasury Advisory

    Corporates | Denver, CO

Summary

Most companies engaged in operational FX hedging will perform at least a cursory annual review in accordance with specified policy requirements. That review often fails to include a holistic assessment of fundamental risk management questions, including “Should we be hedging?,” “How should we be hedging?,” and “Where does hedging fit in our organizational activities?” While the answers to these questions can remain stable for a period of time, many internal and external triggers can impact objectives as well as the most appropriate strategic and tactical measures to address risk. Over time, incremental adjustments to different aspects of a hedging program can lead to a program that no longer aligns objectives and actions to maximize impact.

Identifying objectives and defining the risk footprint

Objectives can shift based on external factors, such as private verss public ownership, competitive landscape, or changes to global risk footprint or risk tolerance levels. Internal factors may also play a role, including changes in key personnel or initiatives to drive automation or cost management.

Identifying tensions and constraints

As companies grow, some constraints will become more complex, while others may actually diminish. For example, a growing organization may have an increasing number of legal entities and cross-border transaction flows across the organization, but they may also grow into intercompany netting structures, create natural risk offsets across the organization, or even migrate multiple ERPs into a single platform. These types of changes can affect hedge accounting capacity, trading costs, operational support needs, and the resulting level of risk mitigation the organization can achieve.

Strategic decisions

Hedging strategies are driven by the combination of the risk footprint and organizational objectives and constraints. When the footprint changes materially, whether through magnitude of foreign exposures, currency composition, or even pricing/contract structures, the same strategies will likely yield a different relative impact on risk metrics. Likewise, changes to organizational priorities will also drive a disconnect between hedging strategy and effectiveness.

Tactical decisions

The operational elements of a program rely on staffing structures, technology solutions, and data flow. As the resources available to an organization change, so do the constraints and opportunities related to hedging. Automation of manual workflows, gaining or losing subject matter expertise within the treasury team, and increasing access to timely data can all be significant variables that could translate to a more effective and efficient hedging program.

Communicating the program

Hedging programs impact a wide array of stakeholders in an organization, including treasury, FP&A, accounting, tax, legal, and business units. Clear communication across stakeholders, from the definition of risk terminology through the orientation to recurring reports and expected results, can ensure a program that benefits the broader organization and can be responsive to needs that may arise from changes that occur outside of treasury.

When is the right time to do a holistic review? Below are a few common indicators:

  • If your hedging policy is no longer a relevant document for onboarding new hires because it doesn’t convey meaningful information
  • If your program was data driven in its design, but the original dataset is no longer directionally representative of your organization
  • If key stakeholders would articulate their understanding of hedge program objectives differently
  • If the treasury team spends more time fielding questions around what the program is not achieving than communicating its intended results
  • If the people and technology tools available are materially different from the resources available at program inception

Companies’ needs will evolve at different rates and will factor in distinct sets of objectives and constraints. But the one constant element in a successful hedging program is the alignment of objectives, strategic and tactical decisions, and program communication.

Chatham Financial corporate treasury advisory

Chatham Financial partners with corporate treasury teams to develop and execute financial risk management strategies that align with organizational objectives. Our full range of services includes risk management strategy development, risk quantification, exposure management (interest rate, currency, and commodity), outsourced execution, technology solutions, and hedge accounting. We work with treasury teams to develop, evaluate, and enhance their risk management programs and to articulate the costs and benefits of strategic decisions.


Schedule an introductory call

For support and guidance in developing an FX hedging program, schedule an introductory call with our advisory team.

About the author

  • Amanda Breslin

    Managing Director
    Treasury Advisory

    Corporates | Denver, CO


Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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