Particularly during turbulent times, good risk management requires professional work rather than better forecasts or superior tools. In this article Jochen Schwabe comments on recent project-related experience.
The level of interest in the issue of FX management correlates with exchange rate volatility. Since the end of 2014/beginning of 2015, this issue has again been en vogue due to the extreme fluctuations of the US dollar, Swiss franc and the rouble, not to mention the recent devaluation of the renminbi. These events trigger the appearance of numerous specialist papers from so-called ‘experts’ who explain how the future policy of the Fed or the Chinese government should be interpreted or who advise us to rely on new, better and superior tools or strategies: more options, ideally structured, overlay strategies and the like. Two key messages here:
- Anyone who knows which direction the markets are going to develop in more than 50% of cases neither works as a consultant nor as an ‘expert’ and doesn’t give interviews in specialist journals; preferring instead to enjoy their wealth in peace and quiet.
- At the end of the day, everything which generates a gain or a loss is speculation rather than a hedging instrument. And no instrument is sustainably better than any other. Arbitrage ensures this.
We have carried out more consultancy projects related to FX risk management in the last six months than in the preceding two years. This allows us to draw several conclusions.
1. Accurate risk identification and analysis are key
Every business model has its own pricing mechanisms. While oil companies pass on the volatilities related to the US dollar and oil prices to us consumers via digital price displays at filling stations in real time (and therefore are not themselves exposed to FX risk), car manufacturers bear risk for periods considerably longer than a forecasting horizon of one year, given that they can’t afford to correspondingly adjust the prices of their products in foreign markets annually.