This article kicks off a new series of posts that will help treasury professionals understand conventional FX risk management practices and how they fit into a successful strategy. There’s no better way to begin than to ask ourselves, “why do companies bother to use any of these conventional practices?” Let’s begin with a quick review of the survey results from Top Trends from the 2018 FX Risk Management Survey Results. A review of these results suggests the reasons cluster around a few popular objectives:
Smooth impact of FX on financial results over time
Protect budgeted results
Assist in forecasting future financial results
Risk management’s objective is certainty
Survey responses are different pleas for the same progress: certainty. You can call it “predictability,” but that term raises eyebrows by implying we can predict future outcomes. Risk management -- the pursuit of greater certainty -- acknowledges there are future outcomes we cannot know. To produce predictable results, we have to reduce the impact of variable, external factors we cannot control. For example – we don’t know what will happen in the financial markets.
Don’t just do something, stand there
Most people think of objectives as goals that require immediate, persistent action towards achievement. Sometimes, no action is necessary – at least not yet. The key is to know when it is time to act.
Typically, companies have too few resources for too many problems. You may have heard this saying, “put out the wildfires, and let the brush burn.” Regardless whether FX risk has reached the wildfire threshold, it’s essential to monitor its potential impact. So, how do we know when the brush fire reaches wildfire status? Every company’s wildfire is different. A well-posed FX risk management objective specifies when action is required. A strategy defines what actions to take. Together, they define how much action is needed.
How to define your company’s FX risk management objective
Here’s how to structure an objective that, together with a strategy, will deliver the certainty your company needs most:
Identify what metric(s) your company must protect
Example: EPS, operating margins, cash flow
Define the threshold of impact that makes executives squirm in discomfort
Example: ($0.02) unfavorable EPS versus last year
Since we can never eliminate risk, how often is too often for bad outcomes?
Example: once every twenty years
Sometimes companies’ objectives (need for certainty) are too great to be met by any strategy, given their exposure portfolio. Even then, defining an objective and formulating a strategy will prepare the company to understand how frequently it might fail to meet its organizational goals.
In the next article, we will discuss how probability can be used to understand and reduce your company's FX risk.
About the author
Chuck Brobst is the Managing Director of Analytics and Innovation Strategist at OANDA Corporation. He teaches graduate courses on risk management and banking at DePaul University. Previously, he founded GFM Solutions and spent 15 years in global markets divisions of BAML and ABN-AMRO Bank.
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