Risk Management

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Managing Financial Risk in the Face of Uncertainty As the global financial crisis demonstrated, every market participant is affected by extreme market events. Only with complete visibility into various risks can treasurers be confident in their risk management practices.

Managing Financial Risk in the Face of Uncertainty

by Jacqui Drew, Senior Solution Consultant, Reval

Sunday 17 June saw Coca-Cola Hellenic’s entire treasury team gathered in the office waiting for the result of the crucial Greek general election, which many observers had billed as a referendum on the country remaining in the Eurozone. If the anti-bailout parties won, the team would start executing changes immediately.

In the end the pro-bailout parties won and the fears of an imminent Greek exit receded. However, Coca-Cola Hellenic, like many other companies, continues to face the challenge of identifying and managing risks - from commodity volatility to interest rate and foreign currency risk.

A risky world

In June 2012, right after the aforementioned elections, Reval hosted a webinar with Coca-Cola Hellenic to discuss the financial risks treasurers face as a result of the Eurozone crisis. We asked the more than 100 treasury professionals who attended a series of polling questions, which revealed their concerns and preparations for a potential ‘Grexit’.

FX risk management

Perhaps unsurprisingly, given the nature of the Eurozone crisis, 45% of those surveyed said foreign exchange risk affected them most in today’s turbulent marketplace. While no-one knows yet what will happen, the essence of managing foreign currency risk is managing uncertainty. Treasurers are struggling with the impact of extreme market volatility and watch as euro spot rates shift, often as a result of political events, such as Greece borrowing money from the International Monetary Fund in April, the launch of long-term refinancing operations (LTROs) by the European Central Bank in August and lately the Greek elections.

To manage FX risk proactively, corporates should identify exposures across the enterprise. While this may not be a new tactic, the euro crisis adds a new dimension as it is not enough just to monitor exposure to the euro, but rather to the individual countries within the Eurozone. For example, if Greece were to exit the Eurozone and a new currency to be introduced, companies need to know their exposure to Greece. Many traditional treasury systems are not able to make this distinction.

One of the ways to reduce risk is natural hedging. Many corporates are looking to match revenues and costs in the same currency and, more importantly, match funding in a country to the investment in that country. This reduces the number of hedges, reduces costs and complexity and avoids unhedged positions.

When hedge accounting is applied, the time and effort invested in understanding markets and volatilities could pay off for corporates. If the effectiveness of the hedges is monitored continuously, over-hedging can be avoided and dynamic changes can be made. Also, although many banks are eagerly trying to show the benefits of hedging with options, risk managers who analyse volatility curves and understand underlying constructions will realise that collar strategies may actually be inefficient in emerging markets. It is important to analyse hedge accounting strategies and find out whether a forecast transaction is highly probable in the current environment, as this is a requirement for compliant hedge designations.

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