Published: January 01, 2000
The dynamic FX landscape has fostered a more sophisticated and comprehensive approach to FX risk on the part of corporate treasurers. For corporations and subsidiaries operating in Europe, the Middle East and Africa (EMEA), the impact of these currency developments is two-fold. On the one hand, the costs associated with production and the repatriation of cash have become more predictable due to reduced volatility in developed currencies. This is enabling many corporates to forecast their FX positions more effectively and take a more comprehensive approach to FX risk management.
For corporations with interests in emerging economies, however, it is a different story. Many corporations had not necessarily expected growth slowdowns to come when they did. Some of these companies are now seeing a negative impact on their overall profits, as the relative values of major and undeveloped currencies continue to affect the repatriation of income from emerging markets into operating currencies, and volatility may also be having an impact on cost of materials or finished goods.
Interestingly, these two opposing trends are driving the same change: an increased focus on FX risk management and a greater need for sophistication in adopting the most appropriate treasury and cash management operating model and tools.
Corporate treasury departments use a variety of operating models and FX risk management tools successfully, However, as corporates in EMEA continue to centralise treasury and cash management functions as well as finance and accounts payables, it is important to review and re-evaluate which combination would be the most effective based on a corporate’s current and future FX needs. A company’s choice of treasury structure will play a role in determining the most appropriate FX tools and techniques.
A traditional treasury model involves the use of multiple country or sub-regional treasury centres, each operating relatively independently, while being centrally governed by a single FX risk management policy. Individual, independently operating business units will often look to leverage relationships with a local bank, which may provide its own tools and services, or perhaps with global oversight for high value transactions. A Global or EMEA regional treasury manager will therefore look for tools to facilitate controls that support autonomy but help to monitor and report on policy compliance. Supporting and enabling the multiple parties in such a structures is critical, and streamlining connection points to a single treasury workstation, or a single FX and payments tool can help ensure that system administrators can keep tight control over who has access to initiate or approve transactions, and thus to manage FX risk.
In EMEA, a typical model is the centralised treasury, where all the company’s treasury and liquidity operations are managed by a team in a single location. The common sets of accounts and zero balance structures allow greater visibility to company assets and liabilities, and facilitate an easy way to support company cash management and forecasting objectives. For example, for cross-currency receipts, a corporate treasury can utilise its increased visibility to ensure that customers are fulfilling their debtor obligations in the correct currency.
In this instance, the most appropriate tools could include physical pooling and netting, as well as multi-currency notional pools, whereby the notional value of bank accounts in multiple currencies is converted to a single currency, giving the corporate the opportunity to offset debit interest against a single notional currency balance. This can mitigate the need to complete a physical exchange of funds to cover individual positive or negative balances. However, this structure may not suit all cash management operations and may be reliant on, for example, cross guarantees and credit relationships with banking providers. Corporates which have been operating under these models for some time may now be considering refining processes by re-introducing traditional currency swaps for certain currency pairs where clear benefits and efficiencies may be gained over pooling.
A more centralised cash management approach, growing in popularity in EMEA, is the use of a centralised ERP system in conjunction with an in-house bank, which can be used to consolidate payments into a single legal entity. With in-house banks, corporates can use their buying power to get better pricing for cross-currency payments and other banking services from their banking providers. In-house banks also facilitate greater aggregation of payments and receipts for netting purposes. However, in order to get the most from an in-house banking structure, it is important for a corporate to strive for centralised and straight-through processing (STP) around its cross-currency payments and to have access to the necessary information. This model can be very effective in managing exotic risk in emerging markets where the business has a high volume of payments and receipts and is looking to limit foreign exchange transactions. In such cases, companies may also be able to reduce emerging market risk by offsetting payments and receipts in a particular market. [[[PAGE]]]
Where payments related to third parties are concerned, such as vendors, suppliers, or contractors, a common model is the use of a single instance of an enterprise resource planning (ERP) or accounts payable system to manage payment and receipts activities for multiple subsidiary accounts. This could involve organisation of ‘Pay on Behalf Of’ structures, or can simply consist of the consolidation of the payment functions to one group, by granting access rights to local bank accounts to a group of centrally located payments specialists.
Wherever payments are executed across borders, there is an FX exposure. A savvy corporate treasury team will insist on understanding the FX exposures involved in their supply chain, and on using their negotiating power to leverage the best possible FX rates for themselves and their supply chain partners. Visibility to reporting on invoiced amounts versus amounts paid, and periodic audits of FX rates obtained for transactions, add confidence to a process that is often overlooked in FX volatility management.
In cross-border payment transactions there is increased focus on getting funds to the beneficiary efficiently, so a centralised payments organisation can begin to look at an ideal mix of payment instruments such as wires, drafts and ACH payments, and creating a solid payee experience. They can also work with suppliers to ensure that invoicing is being performed in the correct currency, and not allowing suppliers to control what exchange rates are used for important transaction flows.
These models and tools are not exhaustive and in some cases corporates may use a combination of different approaches. For example, a corporate may have a decentralised payments model and a centralised treasury management model, and will need to evaluate the available tools accordingly. Every corporate will need to determine the most appropriate risk management tools and techniques based on its unique requirements and chosen operating model.
Through the proper application of these various operating models and tools to support their diverse FX requirements, corporate treasurers have been able to improve their overall FX risk management methodology and find ways to reduce costs and strengthen operating processes. They have also been getting help from FX bank providers, particularly those providers which are staying tuned into their clients’ evolving FX strategies, by adapting traditional bank solutions to meet business needs.
Once good visibility has been achieved, leveraging the most appropriate FX tools and services in conjunction with these systems will further maximise efficiency and minimise risk.
While there is no silver bullet when it comes to eliminating currency risk, corporates should start by leveraging visibility into cash balances and foreign currency obligations via ERP and treasury management systems. Once good visibility has been achieved, leveraging the most appropriate FX tools and services in conjunction with these systems will further maximise efficiency and minimise risk. To this end, many companies are looking hard at the source and frequency of their FX rates feeds into their in-house systems, to ensure that the rates used for business decisions closely resemble the actual trading rates they will receive when executing FX trades. Moving beyond monthly or weekly snapshots of market midpoints, a global treasury manager can now ask their bank to provide them with a live feed of rates, or better yet, with a daily file containing tradable rates for the next 24 hours. This eliminates estimates and true/ups after the fact, and allows for more accurate communication between treasury and their internal and external stakeholders.
Another example of how banks have been helping clients is around the need for analytics. This corporate requirement has risen of late as businesses are increasingly interested in uncovering hidden foreign currency exposures within their operations so they can bring all areas of FX risk into their various operating models. A few banks have begun to offer data-mining and analysis of payment activity and identify opportunities to make those payments more efficiently (different currency, different payment instrument, etc). Through the use of analytical tools, such as value calculators, bank providers are helping to uncover improvement opportunities within existing transactional flows and project cost savings to both corporates and their supply chains. [[[PAGE]]]
While technology is important, treasurers understand that having the best technology won’t necessarily make their organisations more efficient if the people using that technology are not working together in a more connected way. Rather than just providing a proprietary online banking platform or an integrated host-to-host solution for individuals to use, banks have been able to provide solutions that allow teams to work together in a more coordinated fashion. An example would be an approach that allows traders and treasury managers to buy and sell currencies, and the operations team to execute payments off the back of those trades via multiple payment channels.
Corporates operating in both mature and emerging markets are more aware than ever of the potential FX risks that they face and the impact on the bottom line. As such, many are taking the opportunity to review the tools and techniques they use to manage FX risk, while also re-evaluating which operating model is best suited to the company’s needs. With many different operating models allowing for the successful management of FX risk, it is important for treasurers to understand the conditions under which each model works best, as well as how and where banking providers can step in to enhance and support corporate activity.
The need for robust and appropriate FX risk management strategies should only grow as commerce becomes increasingly borderless. Economic cycles and political instability in some parts of the world will also make sure this topic stays top of mind for treasurers in the months and years to come.
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