Strategies for managing FX volatility
Corporates | Kennett Square, PA
Whether driven by a ship stuck in the Suez Canal, global political unrest, or changing monetary policy, managing volatility is a way of life for today’s treasurer. Treasury teams face pressure to perform despite market conditions, with challenging questions from CFOs and boards becoming a regular part of a treasurer’s day. Focusing on key processes and questions can help drive an efficient hedging program able to smooth the market’s volatility.
Faced with FX volatility in the marketplace, your organization should maintain discipline in a well implemented financial risk management strategy. Avoiding acting on impulse and emotion requires a strong program with a well-crafted strategy. Chatham recommends that you undergo a process of:
- Evaluating the potential risk
- Reviewing the risk management objectives
- Implementing the appropriate mitigation strategy
By evaluating the potential risk, you can better understand the main drivers of your risk and how much potential noise your organization is exposed to, given its size and profile. Comparing your potential risk to your program objectives can help drive a clear strategy to implement for risk mitigation. As your organization answers these questions, it will lead to key decisions you need to make along the way to improve your program.
A key question to address is where your program falls on the continuum of risk management strategies, from programmatic to flexible. A programmatic strategy will have more prescriptive hedge ratios, timing, and products. It is usually easier to implement and manage because you make most of the major decisions ahead of time and your team just needs to operate within those parameters. The biggest drawback is the lack of flexibility in the strategy as conditions change.
The other end of the spectrum is a more flexible program where hedge ratios, tenors, and even products may change over the life of the program based on the market or your strategy. This allows your organization to be more opportunistic with its strategy, hedging as the market moves. However, it can be much harder to make operational given the number of decisions you need to make from month to month or quarter to quarter. Maintaining strong controls will be crucial, since your team members will operate with greater discretion.
There is no best practice on the question of flexibility, but the best run programs clearly articulate the objectives of the program to all stakeholders. This will address how much discretion treasury has over the program and how those decisions contribute to your company’s overall strategy.
Once the objectives of your program are clear, effectively communicating the results is crucial. A common question we hear is, “How do I show my program is working?” Having a clear, proactive communication plan in place prevents uncomfortable questions in the face of market volatility. This means having all the relevant data available to illustrate the financial results. It is very difficult to communicate the results of a financial risk management strategy in a vacuum, so Chatham recommends showing how it is one part of the larger picture. It is important to design reports that show more than just the gain/loss on any hedges but also the impact of other areas of the business: revenue and expense forecasts versus actuals, currency breakdowns, etc. (See example below.)
By demonstrating the impact of each element of the results, you can assist stakeholders in better understanding the impact of the hedging program. Additionally, comparing forecasts to actuals shows how missed forecasts can cause further challenges for the hedging program.
Creating these reports and communications highlights the need for data availability. Despite the advances in technology, many companies still struggle to have all the necessary data at their fingertips. As your organization grows, you may find yourselves using multiple systems across different businesses or geographies, making report and dashboard building a slow and laborious process.
Although there are no shortcuts to streamlining data, the results are often worth an investment. Creating as much straight-through processing as possible not only reduces time, it also significantly decreases the potential for human error. This allows your organization to be faster and more accurate. It also facilitates the creation of real-time dashboards that stakeholders can view whenever they want and wherever they are.
A theme we hear from many companies is “no surprises.” With this type of real-time reporting, you can highlight potential sources of noise and risk before you reach month or quarter end. Instead of searching for the reason for volatility, you can identify it and respond to your management team with a strategy to move forward before the impacts hit your financials.
Questions to consider:
- Is data easily accessible?
- Is there straight through processing?
- Are there appropriate dashboards to report in real time?
How to move forward
Many of the strategies outlined here are straightforward but require strategic alignment across your organization to achieve. At Chatham, we partner with many companies to work through these hurdles and will gladly discuss how we can support your organization in creating a successful financial risk management strategy.
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.
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.21-0114
Our featured insights
Achieving automation and efficiency in treasury
Treasury teams can optimize the hedging and hedge accounting process through new technology tools and operating workflows. Whether improving exposure forecast visibility, achieving a faster close process, or improving platform integration, many opportunities exist for treasury to drive efficiencies.
Building an FX hedging program from the ground up
When a company initially evaluates FX hedging, whether due to organic growth, acquisition, or a change in the business model or ownership structure, fundamental risk management questions arise. These usually boil down to "Should we be hedging?," “How should we be hedging?,” and “Where does...
The top 5 benefits of ChathamDirect’s approach to support and client success
ChathamDirect’s unique approach to client support enhances the solutions our clients depend on and ensures you enjoy consistently satisfying experiences whenever you engage with us.
Operational FX hedging programs and the one leading practice you can’t afford to ignore
We often receive questions about how and when to begin or review an FX hedging program. While there are as many variations as there are global companies, the one leading practice that the most successful FX hedging programs have in common is the alignment of objectives, actions, and communication.
Performing a holistic review of your operational FX hedging program
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...
ChathamDirect February product update
To deliver on the advantages clients gain from our seamless integration of advisory, operations, and technology, the ChathamDirect team continually enhances our platform, streamlining the way users manage their exposures, hedging policies, execution, valuations, and hedge accounting.
5 treasury trends to watch in 2021
To succeed in the 2021 marketplace, corporate treasurers must rethink their financial risk management objectives, strategies, and policies while addressing their team’s changing role within the organization. Recognizing these five trends can help treasurers prepare for success in the year ahead.
3 key benefits to managing your hedging program without spreadsheets
Treasury organizations can replace manual data manipulation and significantly increase efficiencies through system integrations, which have become drastically easier and more cost-efficient with the advent of APIs and the refinement of SFTP connections.