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Operational FX hedging programs and the one leading practice you can’t afford to ignore

Summary

We often receive questions about how and when to begin or review an FX hedging program. While there are as many variations as there are global companies, the one leading practice that the most successful FX hedging programs have in common is the alignment of objectives, actions, and communication.

The “ideal” program is not necessarily the most sophisticated risk modeling, or the least expensive cost structure, or even the simplest accounting method. A successful program results from the combination of decisions that are made and actions that are taken and how they align with the risk footprint and the needs of the company. And just to keep things interesting, these are almost always moving targets.

Companies will often look to benchmark their hedging programs against industry peers, which can be helpful in determining competitive pricing dynamics and investor sentiment related to currency risk. But the structure of a hedging program also needs to contemplate the organizational structure of the company and its legal entities, the flow of intercompany transactions, the global risk footprint, and constraints related to cash, accounting, tax, and risk tolerance, among others. This multitude of factors can lead to very different programs across companies that might otherwise operate in similar spaces. Often the appropriate peer group for a program is one that includes similar fact patterns rather than only relying on industry alignment.

As a company grows, its risk management needs will evolve. This could stem from global expansion, maturity of business lines, margin compression, changing sensitivity to risk, or even internal efficiency or automation initiatives. This could also include a change in ownership structure from private to public or vice versa, and the associated change in objectives and communication requirements.

Whether a company is building a hedging program from the ground up or performing a holistic review of an existing program, there are a few fundamental questions to answer:

Should we be hedging?

  • Where does risk present itself in the business model?
  • How much risk do we have, and can it be mitigated naturally?
  • What are the objectives of the program?

How should we be hedging?

  • What strategy best supports our objectives?
  • What tactical decisions support our strategy?
  • What are the key constraints for our organization related to hedging?

Where does hedging fit in our organizational activities?

  • How are activities documented and communicated?
  • How are competing priorities evaluated?
  • How is effective risk mitigation versus resource utilization evaluated?

A successful program is one that balances a company’s objectives and constraints and targets an appropriate degree of program complexity, cost structure, and flexibility to meet stakeholders’ needs. And as the needs of the organization evolve, the program may need to evolve as well.

Chatham Financial corporate treasury advisory

Chatham Financial partners with corporate treasury teams to develop and execute financial risk management strategies that align with organizational objectives. Our full range of services includes risk management strategy development, risk quantification, exposure management (interest rate, currency, and commodity), outsourced execution, technology solutions, and hedge accounting. We work with treasury teams to develop, evaluate, and enhance their risk management programs and to articulate the costs and benefits of strategic decisions.

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About the author

  • Amanda Breslin

    Managing Director
    Chief Operating Officer

    Denver

    Amanda Breslin is Chatham’s Chief Operating Officer. She leads our business practices to ensure the utmost process efficiency and the highest quality client deliverables.

Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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