Optimising Hedging Cost Management

Avery Dennison

FX hedging costs at global materials science and manufacturing company Avery Dennison needed reining in further. With most other methods already deployed, it turned to a very modern take on VaR to achieve the required results. For its achievements, the company was shortlisted for the Dutch Association of Corporate Treasurers (DACT) Annual Award.

Avery Dennison is a US-based multinational firm specialising in the design and manufacture of labelling and other functional materials. It operates in more than 50 countries, generating revenues of more than $9bn (2022).

The company’s global set-up means FX hedging is an essential treasury responsibility. However, the cost of doing so is always under scrutiny. Even though it has already deployed a wide range of mechanisms to try to manage the forward points of its contracts – including reducing exposures, competitive pricing through a multi-bank electronic trading platform, and establishing STP – treasury felt pricing was not optimal.

The first cost-management approach the team took was based on guidance from two of its relationship banks. The advice was to use an efficient frontier approach to save on forward points with an acceptable Value-at-Risk (VaR). Later dubbed VaR 1.0, this hedging approach was implemented in Q1 2019.

The efficient frontier model aims to establish a set of FX portfolios that provide peak returns for a given risk level. Efficiency is achieved when no other portfolio can offer higher returns for a lower or equal amount of risk.

Using VaR to determine the overall risk of its FX portfolio, Avery Dennison was using portfolios at the flatter part of the curve to save on forward points, without taking too much risk. To do this, it had developed its own spreadsheet to run the analysis. Having been reviewed by the banks, and extensively back-tested, it was applied to the firm’s monthly balance sheet FX exposures.

Call to automation

Avery Dennison’s VaR 1.0 hedging approach came to a halt in March 2020 as Covid-19 hit. Correlations (whether currency pairs move together or diverge) between currencies had collapsed. This saw treasury revert to full hedging. However, its spreadsheet model was now taking two and a half hours per iteration. It was time to automate.

The firm’s TMS provider, Kyriba, proposed its FiREapps solution along with a development schedule for an automated VaR 2.0 solution. Within six months the new SaaS-based hedging approach was live.

Cutover to the new approach meant results were now available in minutes rather than hours. A total process time per month of between one to two hours, including decision-making and execution, was now achievable.

And where previously treasury had plotted 10 points between fully hedged and positive carry, now it models thousands of points, shortlisting a few from which one is selected. Extensive back-testing for the year preceding commencement has helped to fine-tune parameters. Based on this, treasury set the following thresholds to further manage risk:

• Maximum portfolio VaR of $250k at 95% confidence
• No currency exposure to exceed $10m
• No more than two currencies permitted an exposure above $5m

Results matter

Avery Dennison achieved significant savings during Q2 and Q3 2023, with only one negative month. “We maintain flexibility,” explains Sandeep Nene, Director Treasury, Avery Dennison. “At any point, we are able to switch back to full hedging in the event of a black swan event, and we monitor results at several points during the month.”

Group-wide application has been aligned with FP&A, because outcomes have an impact on the business unit’s management results, and also with Tax, where correlation of exposures across entities and jurisdictions can result in uneven tax treatments.

“Currently, all VaR 2.0 hedging is carried out at our in-house bank in the Netherlands,” says Nene. Where initially it was used only for IHB-entity exposures, the process now covers these in other entities, “hence it no longer triggers FP&A and Tax concerns”.

Reflecting on the importance of treasury’s positive approach to new challenges and opportunities, Nene notes considerable technological development over the past few years, while at the same time, the financial markets appear more volatile than ever. “Both developments mean that you have to be on top of your game and continuously keep your eyes open for new solutions that can either enhance efficiency in the processes and/or improve the cost-benefit versus risk.”

For the Avery Dennison team to be shortlisted among peers for the DACT award, “with other great initiatives”, is for Nene not only a “morale booster for the team” but also “a solid confirmation that we are approaching our journey to excellence the right way”.