The end of last month saw the European stock markets tumble and the biggest devaluation of the yuan, which was described as Black Monday. The quick, yet steady recovery meant that the markets surged and £29 billion was added to the value of FTSE 100 companies. Treasury Insider spoke to Natasha Lala, managing director for Solutions for Business at San Francisco-based financial technology company OANDA. Operating for 20 years, OANDA was one of the first to provide foreign exchange information on the internet and provides a platform where people can speculate about the currency market.
How significant was Black Monday for the financial industry?
It’s clear that the situation in China surprised a lot of people and what makes it especially impactful is that people were lulled into a false sense of stability, as the rates for pegged currencies do not change often and the currency remains flat. More importantly, for a treasurer that works with risk, in particular, it looks like nothing is happening. Black Monday was significant as when a central bank drastically intervenes with their pegged currency, it creates havoc. On a day like that, we have a unique view because we have access to liquidity and pricing information in the interbank market, so we know what is going on. Getting reliable data and figuring out what is going to happen becomes a real challenge. The knock on effect when central banks intervene is that investors get nervous and with an event like Black Monday, it becomes confusing as people are trying to understand risk as it starts to ripple through to other currencies and asset classes. If you were just looking at the Chinese yuan on that day, you would have quite had a big shock, but this is only half the picture because many emerging markets followed suit.
To what extent do foreign exchange fluctuations affect the corporate treasurer?
Unfortunately and not very surprisingly, it creates a large impact. The reason for this is mostly because what happened was large move and it happened overnight. When any kind of central bank is intervening and volatility increases, future challenges are expected for corporate treasurers. The other challenge for treasurers is dealing with a change that has broad impact. If you were just doing business in China, you would have one kind of issue. On the other hand, if you were doing business with other emerging markets, there would be a whole host of other secondary effects that you would need to be concerned about. After what happened on Black Monday and what happened in the days following, it is evident that every day is a new adventure. Even on that Monday, there was a mini flash crash on the Australian dollar as it dropped by nearly 3% and recovered the following day, which was quite alarming. The treasurer, in that case, is faced with needing to find reliable data on which they will base their risk management decisions.
How have these changes in Chinese currency affected hedging?
What we’ve noticed is that for many companies that were not hedging, an event like this creates an immediate need. For those that do hedge, they have a different set of challenges. The first question that needs to be asked is whether accurate information to make decisions is at hand and whether a reassessment of a portfolio is required well in advance. During a period such as Black Monday, volatility creates a challenge of obtaining liquidity and a concern arises of whether there should be one source of execution or many. For hedging strategies, the Renminbi is a peculiar currency, as there is an onshore and offshore aspect to it, but it also affects hedging strategies for other markets, like Turkey, South Africa, Vietnam, Thailand, Poland, Hungary and others. These countries are impacted by the movement of the Renminbi, and the treasurer must have currency data to be able to reassess their portfolios and then react accordingly.
What has OANDA been doing to mitigate currency risk?
As a foreign exchange company, we’re uniquely positioned to handle this kind of risk because providing a foreign exchange marketplace has been our core business for 20 years and we definitely have an advantage in that respect. What we have found in this situation is that the foreign exchange market moves so quickly. What we advise our clients to do is to use technology to be able to monitor and react to these types of market moves: automation is key. We have access to a broad range of foreign exchange data that is not generally available, but we can make it available to our clients. It allows us to monitor our risk on a real time basis and have the ability to offload this risk to the interbank market in milliseconds. We actually have one of the largest databases of exchange rates going back for decades and it also allows us to stress test our own risk model which gives us the confidence to automate a lot of these strategies. For most treasurers, it’s not feasible or required to operate a real time hedging strategy; that might be a bridge too far for some companies. But fundamentally, the concept of getting accurate FX data to make decisions and automating the analysis applies to any enterprise. If I’m a treasurer, I need tools to react and monitor the breadth and speed to which changes are happening.
In the past decade, what has been the biggest FX risk for treasurers?
When I walked through the door at OANDA 12 years ago, the price for the euro-dollar, which is the most liquid currency pair in the world, would change once every few seconds but now it changes many times a second. This implies that because everything happens at such a fast pace, treasurers cannot rely on a manual procedure that marks their portfolio to market once a month. People focus on the shock events and say that situations like Black Monday create the biggest risk, but the systemic risk created by an inaccurate view of one’s FX risk can be just as impactful. It is not realistic to assume that I can monitor my FX exposures without some level of automation. Treasurers need to assess FX continuously to stay on top of swings in their portfolio – and investment is needed in the data and tools available to today’s treasurer.
Which regulations have helped cross border foreign exchange transactions take place?
It’s hard for a regulation to contain the impact of an event like this, in particular when a central bank intervenes in this sudden manner. China is trying to internationalise the Renminbi and the country is moving towards this. China is unique from a regulatory perspective because of the way that the currency is structured and you can see with initiatives such as the Shanghai Free-Trade Zone and the China International Payment System, this increasing flexibility favours the payments side of regulation. For treasurers, because it is not a global convertible currency, they are going to be faced with challenges. An example may be if they have payments with onshore renminbi but are hedging with the offshore renminbi, which is an unusual structure because with most other currencies, we don’t have that kind of separation. In the rest of the world, regulation generally allows us to make these cross border transactions and hedge on with the same instrument. For China, until we are further along the road of internationalisation, we are exposed here. Volatility will continue and we have to ensure we are actually creating capability within our treasury organizations to be as prepared as possible.