Unhedged FX Risks Hit Corporate Earnings

There were a number of revealing statistics in the results of a risk management survey released this summer by HSBC in which 200 CFOs – or equivalent members of the finance department – and 296 senior treasury professionals took part.

The most immediately eye-catching amongst them was the fact that 70% of CFOs said that their companies have experienced lower earnings due to significant unhedged FX risk in the past two years, and moreover, that these were risks which their treasuries could have avoided.

The reason why this figure is so high is threefold, according to Holger Zeuner, a director in HSBC’s thought leadership team within Global Markets Corporate Services, who led the project.

The first reason, he says, is due to the geopolitical environment, which has created greater uncertainty about trade flows and thus generated more volatility in the currency markets. Zeuner explains that companies which haven’t been flexible in their hedging policies with regards to hedge ratios, or firms that have continued with hedging programmes designed in a less volatile environment, might have suffered FX losses as a result, and could continue to do so in the future unless they change their approach.

The second reason given by Zeuner is that some treasuries probably didn’t have an accurate view of all their FX risk exposures, and that this problem was likely to be more acute amongst firms where the treasury operations are more decentralised and therefore the visibility of the firm’s global exposures is more compromised.

The third reason why these firms suffered from avoidable FX risk is due to accounting related exposures, says Zeuner.

“A lot of the hedging objectives are often cash flow and liquidity related, but in the end a lot of the FX exposure, especially for the multinational companies with a lot of international subsidiaries, is translation related. For example, if a foreign entity earns $100 on a hedged basis and you’re a euro company, that $100 will translate differently for the group results, depending on whether the euro is trading at 1.05 or 1.20. This is a pure accounting effect, which doesn’t indicate that the risk management of the cash flow for that $100 locally is good or bad, but it’s still an issue that a lot of companies have experienced, especially for those active in more emerging or volatile markets. Very often this kind of technical level, or consolidated earning translation risk, is not hedged fully or is left completely unhedged,” he comments.

Lacking Risk Management Skills

Another interesting point in the survey data is that 72% of treasurers said that FX risk management is one of the most important aspects of their job, while 51% of CFOs said that FX is, in fact, the risk that their organisation is least well equipped to deal with.

That such a large proportion of treasurers highlighted the importance of FX risk management to their businesses is hardly surprising, once a company starts to sell across borders or acquires a foreign subsidiary, this is a fairly natural outcome. But the disparity between the importance of FX risk management to these firms and the lack of confidence amongst CFOs in their firms’ risk management capabilities is significant.

Part of the solution to reduce this disparity, claims Zeuner, is for firms to improve the technology in their treasuries so that senior figures in this department, as well as the CFOs, can have a clear overview of what their risk exposures are so that they can then compare that against their risk capacity and decide whether they potentially need to adjust their FX hedging strategy.

Another part of the solution might be to improve the level of risk management expertise within the treasury, something that 57% of treasurers in the survey said that they would like to see happen. When it comes to FX though, there is perhaps a question as to whether treasurers should be expected to become experts in trading and hedging in this asset class. After all, their bank partners have plenty of FX specialists that they could call on.

In terms of underlying exposures, however, banks are in some regards fundamentally limited in terms of how they can help corporates manage their FX risk.

“We’re happy to help analyse the impact of FX moves and provide solutions for FX risk, but corporates need to do their homework to understand how FX impacts their risk capacity and their key performance indicators from a treasury perspective. We can’t help determine exactly how things like price elasticity will work for a company or, if there’s a large move in the FX markets, whether some of that will be able to be passed on to suppliers or clients of the company. We are happy to discuss this with these firms, but that’s expertise that the company will need – how much of a natural hedge they have in terms of supply chains and offsetting cost bases,” says Zeuner.

Growing Complexity

Making life harder for corporate treasurers trying to effectively hedge their FX risk is the fact that often the complexity of these firms’ operations are growing significantly.

Although the very largest multinational organisations might still acquire new businesses or subsidiaries, the fact that they have long been operating in so many different geographical locations mean that the degree to which their treasury operations are internationalised remains relatively unchanged by this. As Zeuner explains, though, this does not mean that the role of the treasurer has similarly remained static.

“For a lot of these bigger firms, the role of the treasurer has changed, they’re making more use of technology, they’re outsourcing some of the day-to-day operations and are focusing more on financing and risk management from a group-wide net income perspective. These treasurers have often gained what I would call a strategic view, very frequently they have extended the tenors of their hedging programmes, based on how long they’re able to forecast exposures to smooth any further potential impact,” he says.

The next tier down, Zeuner points to medium or smaller sized companies that have experienced significant international growth or have expanded into a new part of the world and therefore added a new range of FX exposures.

“The complexity has grown, especially for those firms that have expanded into parts of Asia where they’re now having to deal with new regulations regarding the settlement of transactions, or getting cash in and out of the country, and this is where we’ve seen a lot of the volatility come from. In addition, the more volatile trade environment between the US and a lot of other parts of the world doesn’t make the job of these treasurers any easier. But in general, the added risk management complexity for these firms stems from the healthy growth story of the company itself,” he says.

In the final group that Zeuner specified are firms with a single geographic subsidiary, or a single but large market risk exposure by sector, as they are more vulnerable to issues driving volatility in that single exposure. For example, firms that mostly trade between Britain and the EU are more acutely exposed to sharper EURGBP volatility, due to increased uncertainty around Brexit negotiations. Separately, companies in the metals and mining sector are particularly exposed to the US dollar and the commodity currencies, and are therefore more vulnerable to issues affecting them.

Time to Invest

Despite the challenges presented by this growing complexity, the HSBC survey suggests that there are reasons for treasurers to be optimistic in the future. While 60% of CFOs from larger businesses in the HSBC survey said that their treasury department has received either no additional resources or have had their resources cut in the past two years, 77% of these CFOs said they expect treasury resources to increase over the next two years. It seems logical that at least some of this additional investment will go towards helping treasurers manage their firms’ FX risk exposures.

Or as Zeuner puts it: “It’s been recognised that their risk management approach hasn’t been perfect, but there’s hope that help will come and that it will be sufficient to reduce the effect of FX volatility for a lot of companies in the future.”

Galen Stops

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