Renato Pestana - TNT Corporation Finance Manager Americas and Asia
Foreign exchange hedging is one of the important responsibilities of each financial executives. If the lack of or inadequate hedging hedging financial results may fluctuate significantly. Taking into account the stakeholders' preferences and risk management goals, develop hedging strategies is essential for the proper business. Once the deal with the foreign exchange risk of the overall attitude, treasurers can find the best approach to risk management and how to hedge operations.
Different forms of hedging
As part of the foreign exchange policy, the primary challenge is to determine when and when not to hedge to hedge. There are typically three types of hedges: fair value hedges, which involves exchange risk of net monetary assets and liabilities; cash flow hedges, which involve actual cash flows and transaction risk forecast cash flow and net investment hedges. One of the most complex commercial reasons is hedged forecast cash flow hedges and hedges of net investments in the field. According to Citigroup 2010 Citi Forex Enterprise Risk Management Survey (The survey included 307 companies), 77% of the Company's foreign currency assets and liabilities rinse currency exchange exposure, 76% of the company's risk exposure hedged forecast and 22 % of the company's investment exposure rinse.
Known hedge exposure
The fair value of the hedging relates to existing financial assets and liabilities and profit and loss account which will re-valuation of financial assets and liabilities of the foreign exchange impact, therefore, to hedge commercial reasons very full. This also applies to the known transactions, such as purchase of machinery and equipment. Hedging transactions are included in the results of equity and income statement to match the cash flow occurs at the time, the initial cost of an asset or a match. Hedge accounting treatment in accordance with the effectiveness of the relevant cash flow to decide. In TNT, we have adopted a conservative approach to hedging, known commitments and net monetary assets and liabilities in foreign currency forward contracts to hedge 100%. We divided the world into developed and emerging markets. In developed markets, monetary liquidity is high, the transaction easier, we use the online forex trading platform to execute these transactions. In emerging markets, monetary liquidity is poor, and may exchange controls, we execute transactions via telephone directly with the bank.
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Hedge uncertainty
However, the projected cash flow, for commercial reasons it is more complicated. While the accounting treatment, as there are many factors affecting the hedge decisions. If you are one-time events, such as the expected contract or acquisitions, financial executives need to decide whether to delay the hedge until it becomes established commitment or determined according to the degree of hedging (for example, carry 50% of hedges and cash flow as close to the date of to increase the hedge). Under continuous exposure to foreign currency, such as purchase or sale of raw materials in a variety of markets, financial managers should consider whether there is a natural hedge, such as currency receivables with a net exposure, in addition, to predict what period the company should hedge risk exposure mouth? hedging merely postponed every company will face economic realities do?
According to the industry, preference shareholders and corporate culture, corporate will answer these questions in different ways. Major capital investment projects such as a euro-denominated company, its headquarters will depend on the formation of dollars in revenue to invest long-term competitive advantage, these companies are likely to hedge U.S. dollar cash flows in order to protect its value. A pioneering the use of high oil exploration or drilling for more opportunities, but during low oil companies to reduce investment, investment and may decide to adopt a natural hedge oil prices.
In TNT, we adopted a hedging strategy in order of importance and uncertainty of cash flows discretion. We work closely with the business sector in order to determine whether exposure to these sectors meet the hedging criteria, and if so, in what proportion of hedging. Normally, we use foreign exchange forward contracts or currency swaps to hedge.
Net investment hedges
Net investment hedges the foreign exchange risk management is the most complex area. Net investment hedges only affect equity and foreign subsidiaries revalued, has no effect on the income statement. Investment in a foreign subsidiary is a long-term decision-making, it can be said that the gains and losses will be offset over time. However, if the subsidiary is to be sold, in order to protect potential gains, hedge commercial reasons is extremely insufficient. There are other factors to consider. Care must be taken to avoid violating consider equity ratio covenant. Must consider the interests of shareholders, as they may seek exposure to certain markets and currencies. Natural hedge may exist, such as local currency debt, while in countries with weak economic fundamentals, this challenge may be more prominent.
In TNT, we adopted the use of foreign currency-denominated debt with local entities to build a natural net investment hedges. By using the internal credit rating models so that the local debt levels to meet the current and future earnings potential. Our approach to the future of this natural hedge against foreign exchange gains and local entities effective level of deductible interest combined.
Other important factors to consider net investment hedges are:
i) the accounting treatment: in particular, whether the hedge for hedge accounting treatment;
ii) economic risk: When we consider the activities in a country, and the performance of the business sector may be expected (including its long-term profit forecast), this point is more subjective.
Share experiences
In the financial and operational hedging involves costs. Thus, hedging decisions need to be careful. In general, to determine the natural hedge of the entire enterprise is the best choice, because there is no impact on cost. If the hedge is determined to be appropriate to the risk exposures and hedging is usually 100% match to make it simple, and are able to hedge accounting. However, if exposure to fluctuations between the value of the hedged exposure date and the maturity date, you need to take extra measures to ensure that the hedge is still valid.
TNT based on experience in a complex international companies to hedge foreign exchange, the financial sector has accumulated considerable expertise. An important issue is the distinction between the business sector and the financial perspectives sector. Businesses do not necessarily understand the concept of hedging, may only be considered a cash inflow is good, and the outflow is not good. However, the financial sector, the goal is more to offset the impact of currency mismatch, and increased certainty of cash flows. Thus, hedging strategies must be consistent, for example, sales denominated in foreign currencies should be hedged not hedged regardless of the ultimate impact is positive or negative. This is not always easy to explain to the business sector, especially when the impact of foreign exchange fluctuations may be especially true under positive.
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To deal with the complexity of a conservative attitude
While the majority of the financial sector as a cost center operation (as in the case of TNT), some remain as a profit center. This will cause financial officer must actually predict exchange rate movements, which may not be the company's business objectives. Finance department may choose to hold a lower cost or hedge currency fluctuations. Another option is to take a combination of methods, consider other risks, such as interest rate risk and commodity risk, and consider the relevance and diversity of different types of risks. TNT experience is preferred to operate the finance department as a cost center, because of the risk of financial executives often take a more conservative approach to risk and profit centers tend to take less consistent approach, which can cause volatility in performance.
Foreign exchange hedging may be a very complex science, but its complexity should be derived from the process of comparing the risk and hedging decisions, rather than the use of hedging instruments. The more diverse and complex hedging instruments, the lower the transparency, the greater the degree of difficulty in the valuation and reporting. Finance team, and the use of information to make strategic decisions and performance of the company to senior market disclosure, are required to learn how to play the role of hedging instruments and how they benefit the company.
Hedge in a consistent manner
Hedging can bring value for many reasons, especially because it improves the predictability of financial performance, strategic planning in favor of investment. Analysts and shareholders want to see more stable performance, while reducing volatility will reduce the weighted average cost of capital. Various factors involved in making a decision whether to hedge when and how hedge. Hedging activities need to follow a clear strategy has been approved by the Board of Directors. Hedge should be simple to avoid the risk of accidental fall. Decision to hedge or not to hedge some form of excessive speculation, few non-financial companies have been asked to assume unnecessary risks in non-core activities. In addition, by adding discretion in hedge operations, financial executives need to predict exchange rate movements, it is a matter outside the scope of responsibility of the majority of the financial sector. However, conservative, simple and consistent way to hedge, can bring significant benefits.
