Tasked with both controlling the effects of multi-currency volatility and keeping costs low, CFOs find themselves with a tricky balance to strike. We explore why harmony lies in establishing strong foundations for FX risk management that improve the identification of threats and lower the cost of hedging.
As noted in our previous blog, the CFO sits at the top of all macro-level FX risk initiatives. Along with their responsibilities of financial planning, record keeping and management, CFOs work with CEOs to create risk frameworks and then direct these strategies to corporate treasury executives.
The success of an FX risk framework relies on the identification of weaknesses, both internally and in the markets. Yet because of the unstable nature of FX rates, volatility and hedging, corporations are struggling to spot the risks. According to Deloitte’s 2016 Global FX survey, 56% of respondents reported “lack of visibility and reliability of FX forecasts is the biggest challenge in managing FX risk.”
CFOs may have a wealth of tools at their disposal to protect against FX risk – but without a reliable window into the currency markets, they’re more vulnerable to paying or losing too much money on their containment strategies. Brazil is a timely example, with corporations like Ambev (part of AB InBev) and JBS recently reporting that hedges on the Real cost them enough money to offset cost savings and eclipse annual revenues, respectively.
Given these challenges, the best practices for a CFO should focus on the foundations of their corporation’s FX risk containment strategy. By improving the way FX rate risk is identified, measured and reported, CFOs can ensure that corporate treasury teams can achieve their objectives in the most cost-effective manner.
1) Start with FX rate accuracy: The idea is simple – accurate rates equal accurate forecasting, measurement and pricing. The easier treasury teams can spot FX risk, the less likely they are to implement needlessly expensive hedges. No matter how diverse or intelligent a risk management strategy is, its execution relies on good FX rates. Having a trusted sources of rates is equally important, as this reduces the risk brought by using disparate feeds.
2) Make cost efficiency as important as success: An overbought trade or a rapidly declining currency 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 – yet again, the accuracy of this strategy relies on the ability to identify FX risks.
3) Ensure that a clear, detailed operational framework exists: From as far back as 2007, the IMF has touted the need for corporations to have a strategy that clearly defines how multicurrency risk exposure is to be identified, measured and hedged. Corporate treasury teams rely on the CFO for this clear delineation of responsibilities and the hedging strategies at their disposal.
4) Maintain an open line of communication with the board: Above and beyond a healthy level of collaboration with the CEO, the creation of 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 ultimately empower corporate treasury teams.
The need to protect revenues from both multicurrency volatility and costly hedging is forcing CFOs to come up with intelligent solutions to FX risk management. Yet being smart can be as simple as being right – by improving how FX rates are sourced and risk is assessed, CFOs can empower corporate treasury teams to make smarter decisions.