How to Convince your CXO to Hedge Forex

Sherlock-1000x500.jpeg

In this article, we help you to anticipate known sticking points that have kept other companies from choosing to hedge FX risk.

If you spend ten minutes searching the internet on the psychology of business decision making, you’ll recognize:

  • companies’ decision making processes are typically flawed, and 

  • individuals’ tendencies are prone to snap judgements that are not easily changed. 

And, if you spend an hour reading related articles, you’ll wonder how any organization overcame all the potential pitfalls to make any good decision – ever. But the biggest hurdle is summed up by one word: predisposition. Our minds work by putting to rest the things we think we know – and worse – supporting what we think we know by cherry picking supportive data. We all fall victim to cognitive biases that are very difficult to overcome to make unbiased decisions. 

So, one of the worst situations a treasurer might face is the need to convince executives or board directors who previously voted “nay” on FX hedging to reconsider their decision. If the topic wasn’t previously broached, treasurers can preempt executives’ concerns before they even realize they have them. 

Our prior article discussed tools you can use to advocate constructively for FX risk management. [1] In this article, we help you to anticipate known sticking points that have kept other companies from choosing to hedge FX risk. 

 

The Decision: It’s Elementary…

Sir Arthur Conan Doyle said (via Sherlock Holmes), “When you eliminate the impossible, whatever remains, no matter how improbable, must be the truth.” An unexplained, or otherwise anticipated “no” to the question of hedging FX is like a mystery. The way to decipher why executives won’t hedge, and convince them to act, is to remove the possible arguments against hedging, one by one. If the reasons to hedge are insufficient to prompt action, you must negate reasons executives are inclined to say no. 

The following list addresses many common reasons and counterpoints. Some might strike readers as unimportant, but be cautioned, each reason listed was sufficient to stop at least one company from pursuing risk management. While the list is not exhaustive, it can be a helpful guide to counter-rationale measures treasurers must offer preemptively to discourage executives from issuing reactive resistance to proposals for hedging.  

Counterpoints for 8 Reasons (Excuses) Not to Hedge

1. The company lacks resources to manage risk

Counter-rationale:

  • Develop a brief presentation of the strategy and expected benefits [2]

  • Prioritize necessary scope to optimize achievable benefits vs. necessary resources 

  • Define necessary roles and get buy-in from existing employees who must participate to show the resources are ready and willing (e.g. treasury, accounting, FP&A)

  • Identify internal and external resources to be used

  • Incorporate any of the following “reasons” that must be addressed. Anticipate every “nay” vote and respond to it in your first presentation 

  • Then, and only then, present to executives 

2. The company’s exposure is immaterial

Counter-rationale:

  • Identify metrics that mean the most to executives

  • Perform VAR-based analysis to show how materially FX can impact your company’s metrics [3]

  • Message effectively. If the potential impact of FX is a 3% reduction in sales, compare FX hedging to what investment executives would make to grow sales by 3%

3. Hedging is “taking a position” on the market

Counter-rationale:

  • Every company that incurs costs in one currency and revenues in another has FX risk. Not hedging that mismatch is, arguably, speculative. Most companies having material risk will at least hedge their operating margins

  • Provide VAR-based analysis of the potential FX impact on sales, costs, and margins. This demonstrates that the company needs to hedge to avoid taking a position on the market

4. Hedging reduces strategic or operating flexibility (e.g. potential sale of the company or some entities, or a change in procurement or manufacturing strategy, such that management is unclear of the long-term exposure portfolio).

Counter-rationale:

  • To an extent, this is a valid argument not to hedge, or to exclude certain exposures. Spurious exposures should not be hedged. If a company is likely to move manufacturing from, say, China to Vietnam, you’d certainly hold off on hedging related CNY exposure

  • However, the prospect of selling an entity (and related currency exposures) might be even greater reason to hedge its exposures. The functional currency value of the entity will be based on some form of discounted future performance

  • For instance, if your company were to sell an entity that sells most of its goods in EUR, it would certainly make sense to hedge EUR sales. A decline in EUR would hurt the discounted value of future sales, and hedges of future EUR sales would partially offset the decline

5. We use price adjustments to offset currency effects on our performance

Counter-rationale:

  • Companies using dynamic pricing as a way to hedge currency exposure must thoroughly understand how changing prices impact their customer, the elasticity of their product or service in the marketplace, and their competition’s response. And the resulting effect is unpredictable 

  • Currency hedging is a one-factor decision that has few if any side effects, other than the benefit of enabling the company to keep pricing consistent while preserving profit margins

6. Hedging is too expensive

Counter-rationale:  

  • The essential argument for FX risk management is to provide certainty of a company’s outcomes, not to speculate when a currency will or won’t depreciate

  • While it is true that some currencies carry a large cost to hedge, the cost of hedging market risk is commensurate with the risk eliminated over the long run

  • Even if the long run cost of hedging is equal to the long run depreciation of an exposure currency, it is advantageous to hedge the currency for the predictability hedging affords 

7. Financial reporting of hedging activities is too complex

Counter-rationale:  

  • Two decades ago, global bodies that oversee financial reporting standards introduced arcane ways for companies to report financial risk management activities, and treasurers were roiled by its impact for many years

  • Recently, standard-setting bodies have eased requirements and associated reporting activities

  • Moreover, numerous services and solutions are available to assist or automate the process

8. Only banks win when companies hedge

Counter-rationale:   

  • Executives’ focus should be on the company’s need for certainty, and banks are a necessary partner. So, it is important that execs understand the role banks play 

  • Banks have long provided market liquidity to clients by dealing market-based products. They are heavily regulated and must reserve massive amounts of expensive capital to provide services to their clients. So, banks must generate fair returns on required capital reserves in a way that incorporates market and credit risk incurred, and transaction funding costs

  • To ensure fair pricing, treasury groups should devise an efficient execution strategy to provide reasonable transparency around financial transactions with banks using multi-bank dealing platforms or third-party services 

 

Summary

Sherlock Holmes excelled at unraveling mysteries, motives, and anticipating next moves – all in an effort to protect others. Treasurers may find themselves in a similar role and can use the methods outlined above to anticipate and remove obstacles to save their companies from volatile FX rates.

A treasurer’s best route to save the day is to get ahead of executives’ motives and predispositions with ready responses to inevitable questions. 


[1] See “Why Not to Not Hedge Your FX Risk,” June 18, 2019.

[2] See “FX Risk Management Objectives,” April 3, 2019.

[3] See “Measuring FX Risk: Crises with Confidence,” April 17, 2019.



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.

OANDA provides reliable, accurate FX data trusted by finance professionals at Google, Disney, KPMG, Tesla, and Twitter. Save time and automate FX conversion with this popular API FX data solution. Start your Free trial today.