As 2022 shapes up to be a volatile year, evidenced by equity prices and surging interest rates, inflation and changing labour market dynamics have introduced unforeseen challenges. Amol Dhargalkar, Global Head of Corporates, Chatham Financial, outlines five strategic and operational moves treasury professionals should consider to take advantage of capital market opportunities and manage financial risk successfully this year and beyond.
Address inflation and interest rate volatility
Inflation globally continues to grow beyond central bank targets due to several factors, including fiscal and monetary stimulus, supply chain disruption, and emergence from Covid lockdowns. Central banks in most Western economies such as the US, UK, and the EU have laid the groundwork to remove accommodative monetary policy as inflation rockets around their economies. In addition, low interest rates have fuelled demand from consumers and businesses alike.
With the end of fiscal stimulus and a more aggressive monetary policy designed to fight inflation, treasury teams must contend with rising interest rates on impending debt maturities or existing floating-rate debt. Although the tightening cycle is already priced into the market, treasurers should still consider hedging this risk for several reasons. First, central banks may raise rates more aggressively if inflation continues as the market has already begun considering 50-basis-point hikes rather than the traditional 25-basis-point rate hikes for the US. The same goes for other central banks.
The cost of locking in rates could also increase in the future if market expectation shifts upward. Historical data shows that the forward curve often underestimates the level of rate hikes during tightening cycles. If you elect hedge accounting, you’ll also gain the reporting benefit of removing P&L volatility on your financial statements.
Additionally, much of the current inflation dynamics are driven by rising commodity prices, which will likely only decrease with either demand reduction or an increase in supply. Consequently, treasury teams have spent significant time on understanding commodity drivers of input costs and developing hedging programmes (both physical and financial) with other key stakeholders.
Get ready for a SOFR world
While the UK has successfully transitioned away from GBP LIBOR to SONIA, and the Eurozone has revised EURIBOR and transitioned from EONIA to €STR, the US has generally lagged behind these economies. If you expect to issue debt or hedge interest rates in USD this year, you should assess implications of operating in a SOFR environment. Subject to some exceptions, previous hedging structures, such as new USD LIBOR debt and derivatives, will generally not be allowed in 2022 and will face limited availability of executing LIBOR-based derivatives. LIBOR’s preferred replacement, SOFR, exists in many different forms, making specification and selection more challenging. You may also need to restructure hedges to match debt or hedge fixed rate debt back into a floating rate leading to a derivatives-based conversation around SOFR selection and availability.
Reassess your FX programme
Market-driven triggers, such as missed forecasts and supply chain disruptions, may have shifted your currency positions and priorities, creating a mismatch between your FX programme and the objectives it aims to achieve. To realign your programme with its goals, start by focusing on fundamental questions, such as: “Is our FX programme doing everything we need?” and “How can we run our programme more confidently and efficiently?”
This will help reset objectives, so you can begin benchmarking against peer companies and reset your approach. To streamline the process of assessing exposures, determining hedging strategies, and executing the FX programme, companies are increasingly investing in specialised technology solutions that integrate with the overall technology stack. APIs allow for easier movement of data between platforms, enabling customisation of processes and technology to maximise efficiency. Importantly, the increased ease of integration can help your organisation get more from available tools, rather than trying to fit your processes into difficult-to-modify technology platforms.
Engage stakeholders beyond treasury
If commodities represent significant input costs for your organisation, hedging has likely become a higher priority than ever before. Unlike with interest rate or currency risks, however, your team may not control many of the decisions around commodity risk management because supply chain or procurement has direct responsibility for supplier pricing.
By engaging with stakeholders in these areas, you can collectively determine whether managing risks with derivatives might provide more control and flexibility than purchase contracts or supplier agreements. You can also avoid the risk of two functions operating at cross-purposes, such as treasury executing a financial hedge while procurement executes a forward purchase. This collaboration also applies to hedging other asset classes where frequent interaction between front, middle, and back offices can ensure the economic strategy aligns with financial reporting.
Embrace the employee-centered labour market
Inflation also affected labour markets as consumer price increases shifted the power dynamic towards employees for the first time in years. This dynamic, combined with the expansion of remote-work arrangements and increased team turnover within treasury and accounting roles, made recruiting highly competitive.
To improve retention while leveraging a leaner team, reassess your treasury technology stack (including TMS , risk systems, trading platforms, ERPs, and business intelligence tools) to see where automating repetitive tasks can lighten the workload. Not only can this save many work hours each week but it can also empower employees to refocus on valuable and rewarding tasks, increasing job satisfaction.
The bottom line
The coming year will bring many opportunities for treasury professionals to demonstrate the value of financial risk management to senior management, boards of directors, and investors. Within this rapidly changing environment, staying nimble and accessing the knowledge and tools you need to execute a successful hedging programme has never been more critical. By focusing on the above strategic initiatives, you can create a resilient, flexible financial risk management programme that continues to achieve its objectives in an ever-changing marketplace.
