Why Not to Not Hedge Your FX Risk

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In this article, we discuss the tools you can use to advocate constructively for FX risk management, even if your executives were unsupportive of risk management in the past.

If only executives spoke as parents do to their children: Mom, can I…? No. Why not? Because you did not eat your vegetables. Or, the infamous, because I said no. At least you’d know there is or isn’t a chance to change their view and what action is required. Some executives have mastered the art of saying, “no” without saying no, while giving no indication why the answer is not yes. “Now is not a good time… Maybe… Let’s get someone to analyze it… What if we do this instead... Let’s put something on the calendar to discuss it in Q4... See if Jane has time to oversee it…”

A longstanding topic in the treasury community is: What can we do when executives or board members decline to hedge? But oftentimes, the response to, “why don’t we manage our FX risk?” is dispensed without clear rationale, lacking empirical support, and leaving the treasury team to wonder: “How can we make a case when we don’t know why the answer is no?”

Two valid reasons come to mind for a company not to manage FX: 1) immateriality and 2) spurious exposures. In the first case, the risk doesn’t matter. In the second case, hedging could make matters worse instead of better. Beyond that, executives must choose unpredictability over certainty to resist hedging. Nonetheless, no means no.

In this article, we discuss the tools you can use to advocate constructively for FX risk management, even if your executives were unsupportive of risk management in the past. In our next article, we’ll explain why some executives have opposed – or otherwise deferred – hedging, so you can craft your pitch to anticipate known sticking points. Data on practices companies don’t use is generally unavailable, therefore our assertions are necessarily experiential and anecdotal. Keep in mind, first impressions are powerful, so make your first approach complete, convincing, and concise. 

 

Is that a Light at the End of the Tunnel, or an Oncoming Train?

When executives resist the need to manage market risk, treasurers feel as helpless as a turtle on its back. They face a lose-lose proposition. No one seeks to tussle with their executives, but treasurers also don’t want to preside over inaction and endure a negative headline.

Here are a few headline examples:

Executives’ apprehensions might be rooted in several causes, some of which are overcome by education, or the right “framing” to put the issue into a relatable perspective. But often, you won’t know what specific argument you’re trying to counter, so you have to anticipate them all. 

 

Tools of the Trade: Turning “Nay” into “Yay!”

When treasurers turn the tide in their favor, the reason usually revolves around some of the following four devices: 

1) Messaging: reframe the deliverable of FX risk management

  • The deliverable of risk management is certainty. [1]

  • Hedging will increase the reliability of well-founded forecasts and key metrics.

  • Hedging will not enable the company to capture only favorable conversion rates. That is speculation, and even the best speculators are wrong roughly 50% of the time.

  • Forget scare tactics and headline risk. Executives do not like fear mongers. 

2) Analysis / VAR

  • Perhaps the most frequent catalyst for companies to begin hedging is when they suffer an unexpected adverse FX impact. All arguments against hedging are refuted, and executives exclaim “mea culpa” to the market and vow to address market risk in future periods. But why did they not understand the potential adverse outcome before it occurred?

  • VAR analysis and similar tools have been used for decades by bank regulators to understand and regulate the impact of market risk on banks. Many companies have adopted similar tools. ALL companies with any known FX risk should perform VAR with adequate frequency to know the potential risk on their performance. [2]

3) Peer comparison

  • Public companies in the U.S. must disclose market risk and hedging activities in their regulatory filings.

  • Executives are frequently more persuaded by comparisons to comparable companies and competitors than they are by their own company’s fact patterns, so you can show executives how extensively others are hedging FX based on their regulatory filings.

4) Survey results

  • Again, executives tend to be persuaded by norms among their peers. Sometimes they need to be shown that “everybody else is doing it,” and there are several good examples available. 

  • Organizations like Wells Fargo, Bank of America, and Deloitte have all completed recent surveys on companies’ market risk management behavior. Surveys indicate what they do and frequently offer insights into why. 

Summary

No risk management program will ever achieve lift-off without strong executive support, but executives bring their own bias to the decision of whether to support an FX risk program. Executives who resist FX hedging place their treasurers in a no-win situation, forcing the treasurer to submit a bullet proof rationale for why and how to manage the potential impact of FX. This article introduced tools commonly used to assert a pro-FX risk management position. 

Because executives frequently do not offer full rationale for their resistance, it is critical that treasurers anticipate arguments against FX hedging, and put forth an effective counter-position. We will address common reasons for opposition and offer counter-rationale in the next article. 



[1] See “How to Use Probability to Manage FX Risk,” April 10, 2019. 

[2] 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.

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