From risk to reward: Managing FX risks efficiently
Foreign exchange (FX) risks can be a nightmare for global businesses. Fluctuations in exchange rates can lead to significant losses or unexpected gains, making it challenging to forecast future profits accurately. In this blog, we’ll explore strategies to help you mitigate FX risks and ensure your business remains financially stable, regardless of market conditions. Whether you’re a small startup or a multinational corporation, the tips we share will be valuable for keeping your business afloat and thriving in an increasingly globalized world.
Set up a risk framework to enable enterprise-wide risk management
As companies start seeking revenues outside their domestic markets, they are increasingly exposed to FX risk. Treasurers are challenged to set up a risk framework to help control currency volatility. This becomes particularly challenging in emerging markets, where currency pairs tend to swing even higher.
Therefore, it becomes critical for companies to develop a solid risk framework enabling enterprise-wide risk management. And typically, risk guidelines should answer the following three questions:
- Risk factors: Which risk factors must be considered by each business unit, and on an enterprise level?
- Risk processes: How should risk be evaluated and hedged?
- Risk reporting: How, and how often should exposures be analyzed and reported on?
Create a holistic view of treasury and risk to gain a complete view of exposures
To stay ahead of the curve, treasurers must be able to identify gaps or disconnects in the workflow that can cloud the global view of their cash.
Gaining a holistic view of exposures begins with understanding that there is a cause-and-effect relationship between cash and risk management activities. Below are five key areas where cash and risk need to be considered together:
- FX exposures: An organization needs to combine data on its global cash position, international cash pools, multi-currency positions, cash forecasts, balance sheet positions, forecasted FX exposures, and input and insights from subsidiaries. Investing in this effort to consolidate information can reduce P&L, lower transaction fees, and strengthen compliance with FX risk management policies.
- Liquidity management: Global development can impact working capital positions, payables, and receivables. Lack of visibility into these positions could result in inefficiencies and expenses. If you are entering a new market, you need to understand the nuances of local governments, businesses and employees, and how these characteristics might impact your liquidity management.
- Cash forecasting: Inaccurate cash forecasts can undermine your company’s liquidity management.
- Counterparty risk: The number of international banks used by companies has been increasing, requiring a comprehensive view of their accounts. Consolidating data across exposures and asset classes creates a holistic view of your counterparty risk, reducing the impact of any financial loss while saving time and resources.
- Commodity risk: Hedging in a global company is a daily activity. Improving collaboration between procurement and treasury improves your ability to measure commodity risk and implement best practices for hedging.
There is no magic recipe to protect against every potential risk; a corporation that knows its risk profile and works to manage it by creating a holistic view of treasury and risk will be better prepared to make sound strategic decisions.
Choose a centralized approach, aiming to identify and manage exposures on a group level
Volatility in the market is higher than expected. As a treasurer, you’ve hedged currency risks thoroughly, however there’s still a significant loss.
You realize you’ve suffered from the impact of FX volatility on revenues and/or the cost of goods. So, what do you do?
You choose a centralized approach, aiming to identify and manage exposures on a group level. Applying hedge accounting, most treasurers prefer instruments such as FX spots, forwards, and swaps to mitigate FX risk.
In general, FX exposure netting is a popular concept. Here, currency positions are not hedged 1:1, but are aggregated first per currency for all business units and then hedged. This way, the number of hedges can be reduced, and costs can be saved for bigger transaction volumes. To further increase visibility in FX exposures and make hedging strategies more effective, treasurers turn toward cash flow at risk (CFaR) or value at risk (VaR) metrics.
And to have complete FX exposure, most companies acknowledge the need for professional FX exposure management. A Treasury Management System (TMS) not only fully automates the workflows but also saves you from broken processes, manual workarounds, and, consequently, time lags, potentially leading to wrong decisions and economic damages.
Apply technology to minimize risk and simplify complex processes
Besides building the risk framework, implementing processes efficiently is also important to minimize risk. However, using spreadsheets for processes is prone to serious errors. For example, here are three factors that make FX exposure management with spreadsheets inefficient and insecure:
- Fat finger errors: Cash flows need to be keyed in manually, often twice or even more often.
- Broken formulas: Market data cannot be imported, and valuations have to be calculated with formulas.
- No audit trails: Data changes are not documented.
You can easily avoid these errors by using a Treasury Management System (TMS). The software also
- captures all cash flows in a single platform.
- evaluates transactions automatically with current FX and interest rate data feeds.
- helps you identify and mitigate FX exposures.
- creates risk reports automatically at any time, providing real-time information for the CFO.
Therefore, using technology is highly recommended to transition from a reactive to a proactive approach, and finally to an advanced approach for FX risk management.
In conclusion, FX risks are an inevitable aspect of doing business in a global economy. However, by implementing the right strategies, you can mitigate these risks and safeguard your business against potential losses. By staying informed, planning ahead, being proactive, and choosing the right TMS, you can ensure that your business remains financially stable, even in uncertain times. So, take the necessary steps today to position yourself for success in the global marketplace.
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