Published: January 01, 2000
With international expansion a key business growth strategy for companies, foreign exchange (FX) risk is at the forefront of treasurers’ minds. By establishing responsive FX and investment policies and making use of the wide array of product sets available, companies have an opportunity to achieve best practice in FX risk management.
Any company that operates internationally is exposed to FX risk. The foreign currency obligation to pay a supplier, or the foreign currency payment a company expects to receive from a customer, is subject to change with fluctuating currencies. In recent years, FX volatility has been exacerbated by macro-economic instability and political uncertainty, with the Eurozone debt crisis, for example, having a significant impact on FX markets.
At the same time, structural shifts in the global economy are prompting many multinational companies to concentrate their expansion in rapidly growing emerging markets. Many of these markets – most notably China – are gradually liberalising their regulatory environments and currencies. However, in many instances, currencies and capital remain strictly controlled, which complicates FX risk management.
The task for the treasury in managing FX risk – and associated counterparty, economic and country risks – is increasingly complex. However, by selecting the right tools and working closely with a trusted advisor, companies have an opportunity to achieve their FX risk management objectives and safeguard their bottom line and future growth.
Visibility is central to FX risk management. Unless the global treasury can see and quantify its FX flows and exposures – wherever they occur geographically or within the business – a company may run the risk of capital or opportunity losses. At a minimum, a lack of visibility at the centre can mean that the full benefits of streamlining and standardisation may not be achieved.
For some companies that operate worldwide or have decentralised operational structures, it can be challenging to achieve complete visibility of activities. Communication links may need to be strengthened between local business units and corporate treasury. Moreover, the central treasury must help ensure there is transparency regarding any cross-currency or cross-border payments to keep any exposures from being hidden.
Once visibility is achieved, the corporate treasury must establish a framework to manage FX risk. In a global company, they may not be involved in every FX transaction - since FX payments are often transacted across multiple geographies, by a variety of providers, and within different entities of a corporation. The key to effective FX risk management is a clear investment in FX policy adhered to throughout the entire company.
There are multiple guidelines to follow when establishing the company’s investment and FX policies. Clearly, the policies must reflect the company’s strategic objectives and its view of the many risks it faces across multiple currencies and countries. Investment and FX policies must be flexible to accommodate fluctuating market conditions and the changing needs of the company; they should also be reassessed on a regular basis.
However, reflecting a group-wide approach to risk, investment and FX policies must also set specific rules for each part of the company that could potentially create an FX exposure. The rules should accommodate requirements of different parts of a company – from corporate procurement to corporate travel management – so that the investment and FX policies are tailored to address their needs while still remaining aligned with the company’s overall risk management objectives.
In order to achieve this goal, treasury should carefully analyse the characteristics of each division and define an FX strategy accordingly. Treasury should ideally be involved in local or regional negotiations – to establish a supply chain finance facility or pay local taxes, for example — that creates FX risk so that it can help ensure proper guidance is followed and obtain timely and accurate updates.
For centralised companies, insisting on such involvement is straightforward. For decentralised companies, a dialogue may be needed to explain the broader benefits of group risk management policies. While treasury may take the lead role in FX negotiations with a global bank, for example, it also can give the local entity assurance that it will continue to have direct access over transaction initiation and, therefore, will retain its autonomy.
It is critical that when an FX transaction occurs – whether it is a simple cross-currency payment or a sophisticated FX hedge – the treasury can be confident that the transaction is in line with established policy. While choosing a local FX provider may make total business sense – it offers the lowest costs locally or may be an important regional provider of other banking services – such decisions need to take into consideration a holistic view of the company’s global FX needs.[[[PAGE]]]
Only treasury is capable of achieving such a broad view. By improving visibility at the centre, establishing global investment and FX policies, and implementing the structures to enforce them, corporations can capture FX exposure across the organisation and better determine appropriate hedging strategies. Moreover, improved visibility enables corporates to leverage their scale to achieve lowest cost pricing for their aggregated FX activity. Companies also gain an opportunity to improve compliance and reporting by rationalising their selection of FX providers. Most importantly, they can manage FX risk more effectively.
The FX market is the most liquid, transparent and efficient market in the world. Companies’ FX risk management must reflect this. By identifying risks wherever they may be in the business, making full use of the wide range of FX tools and product sets available, and adopting best practices, companies can use the efficiency of the FX market to achieve their risk management objectives and enable the business to prosper.
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