Getting the House in Order
Revisiting Treasury Risk Management Policies
by Karlien Porré, Director and James Adams, Senior Manager, Treasury Advisory, Deloitte LLP
With companies facing volatile currency markets and increased risk aversion, many corporate treasurers are going back to basics and revisiting their risk management policies, particularly for foreign exchange risk. In this article, we explore some of the latest thought areas.
A heightened risk environment
Many corporate treasurers used the relatively calm conditions at the start of 2011 as an opportunity to catch up with their housekeeping and complete long awaited tasks. Those that chose to revisit their risk management policies are fortunate enough to be in a more resilient position to weather the volatility that returned in the second half of the year. Escalating European debt concerns, slowdowns in the global recovery and ongoing regulatory changes in the banking sector are just a few of the factors that are contributing to current market uncertainty.
Increasingly, companies that did not have the opportunity to review their policies are approaching us to discuss the lessons learnt from the crisis and latest thoughts in this area. Foreign exchange risk management has always been a topical issue. Although treasury policy in itself is nothing new, the tools and approaches have developed markedly in response to this increased focus.
Before revisiting their policies, companies first need to be clear about what they would like to achieve from a risk management perspective. This requires taking a step back to understand the nature of their risks. Treasurers can then evaluate them in light of the organization’s risk appetite and develop a revised policy. At this point, companies can then effectively consider their use of derivatives and other hedging techniques.
Start with a risk management framework
A common framework for approaching the problem is outlined in figure 1. If we take this approach and apply it to foreign exchange risk management, a series of questions needs to be addressed.
What is my risk?
The three main types of foreign exchange risk that companies typically monitor are transactional risk, translational risk and economic risk.