3 steps to efficient FX exposure netting

FX risks are hedged in one way or the other in many companies. In its most basic form, you hedge every FX position. But you do not have to stop here! Let’s look at an example to demonstrate the advantages of a more rigorous FX risk management approach and how hedging costs can be reduced.

A Spanish clothing retailer with worldwide fashion stores and production facilities has implemented group-wide liquidity planning and hedges FX exposures one-to-one. Operating in nearly 100 countries, the company’s main currencies are EUR, USD, GPB, JPN, and MXN. How can the clothing retailer evolve its FX exposure management?

• 1. Simple many-to-one hedging

  The retailer’s risk manager sums up all USD receipts and uses a single hedge to mitigate the USD exposure. By reducing the number of derivative transactions and increasing transaction volumes costs are reduced. Then, he does the same for receipts in GBP, JPN, and MXN as well as for receivables in all currencies.

• 2. Advanced many-to-one hedging

  Further evolving the FX risk management approach, the risk manager sums up receipts and receivables for USD, GPB, JPN, and MXN and executes a single hedge for each currency. This way the number of hedges can be further reduced, leading to additional savings.

• 3. FX exposure netting

  Finally, the risk manager could apply FX exposure netting and consider cross effects. Looking at functional currency pairs, short and long exposures of its subsidiaries can be netted and hedged together to reduce the number (and volume) of external FX trades required.

It’s clear the retail company’s risk manager would need dedicated software to help manage these more advanced workflows. Treasury Management Systems (TMS) not only offer capabilities for liquidity planning and FX exposure netting, inclusive of integrated market data feeds, but also analysis and simulation tools, enabling the retailer’s risk manager to better understand risk correlations and effectively cut down hedge costs.

If you are planning to move ahead and take similar steps to evolve your own FX exposure management, a review of your organization’s treasury technology is important as well. As you can imagine, hedging FX exposures at higher levels of sophistication cannot be done with spreadsheets anymore.