By Wolfgang Koester, CEO, FiREapps
This article explores the best method to determine acceptable levels of currency risk, and the importance of using accurate, complete and timely data needed to manage those risks successfully and how to report back to the board the success of your currency exposure management program.
Global corporations lost nearly $11 billion in 3Q 2016 alone due to currency volatility, and North American corporations absorbed more than half — $7 billion – of those losses.
It is the responsibility of corporate treasury professionals and finance directors to keep these losses in check, and we know from experience treasury teams work hard to identify and mitigate these shortfalls. When there are shortcomings reaching billions of dollars, it is because faulty data is being used to shape hedging decisions.
More than half of corporate treasury executives surveyed in 2016 said they lacked the visibility and tools needed to adequately manage currency exposures. Additionally, 60 percent of respondents said they relied on manual foreign exchange (FX) tools to do their forecasting. Even more troubling — nearly a quarter said they did not bother to track any FX exposures at all.
Currency risk is the single greatest financial risk facing most organizations. When you consider there have been more significant currency “events” in the last 11 quarters than unfolded in the prior 11 years altogether, the need to effectively manage currency risk becomes clear.
Better risk management requires better data
When 50-plus percent of executives said they lacked “visibility” into their organization’s currency exposures, it means they lacked accurate and timely currency data. In large multinationals, it is common to encounter obstacles across an organization and this holds true when it comes to accessing reliable data. Barriers may include variations in how multicurrency transactions are recorded, how re-measurements are tracked, or variations in reporting due to the sheer size of the organization.
Despite these barriers, treasury teams must collect data from across the organization – a process that can be both time-consuming and imprecise. Often, the data is out of date, further contributing to ineffective hedging. Inaccurate hedging leads to surprises – and, at the end of the day, neither a CEO nor an executive board wants to communicate surprises to shareholders.
Instead, companies must make collecting robust, real-time data a top priority. It is the only way corporate treasury teams and executives can be completely confident in their exposures and risk.
The good news is once reliable data is captured, managing currency risk can be fairly easy.
Consider this: When a corporation lacks methods to gather precise data, the organization will instead settle for an “80/80” treasury-confidence score. In other words, they will accept having access to only 80 percent of their data, and, since it is not timely, they also accept being only 80 percent confident in their data. This translates into an average hedge efficiency of about 64 percent (80% X 80% = 64%).
But there is a more effective method of hedging. It starts with using unimpeachable data. Organizations can then formulate an accurate picture of currency exposure. This enables treasury teams to be fully confident in what they communicate to executives and board members, who in turn can be confident in their hedging decisions.
To visualize this, we encourage treasury executives to map out an efficient frontier, with cost occupying the horizontal axis and risk represented by the vertical axis. This simple technique is highly effective in illustrating numerous risk-reward scenarios. It helps pinpoint an organization’s appetite for currency risk. In our industry, currency exposure management, we refer to this efficient frontier mapping as creating a Cost and Risk Efficiency, or CoRETM assessment.
By identifying acceptable risk levels, corporate executives can focus on running their organizations. They no longer have to concern themselves with the interest rate differential of two currencies; instead, they can operate with confidence in their hedging choices. Reliable data results in confidence in currency positioning – especially during periods of extreme volatility.
At FiREapps, we have been working with multinationals for nearly 20 years, helping them analyze their data and identify their currency risk. Time and again we see treasury teams voicing frustrations about their currency exposures and losses. Time and again, we determine it is because they do not have the right data. When they have the right data, they can transition their hedge efficiencies from 65 percent to 99 percent.
Once they attain this degree of confidence, board members no longer concern themselves with currency volatility. They know they are positioned to withstand any currency shifts. In fact, from a forecasting point of view, we regularly see companies increase their hedge ratios by 20 percent or more.
Wolfgang Koester, CEO of FiREapps, has more than 30 years of experience in developing and implementing currency risk management programs for Global 2000 companies. Koester is a frequent speaker at industry events and is a regular contributor to industry publications, as well as networks such as Fox Business, Bloomberg and CNBC.