Strategies for managing FX volatility

Process review

Faced with FX volatility in the marketplace, your organization should maintain discipline in a well-implemented financial risk management strategy. Avoiding acting on impulse and emotion requires a strong program with a well-crafted strategy. Chatham recommends that you undergo a process of:

• Evaluating the potential risk
• Reviewing the risk management objectives
• Implementing the appropriate mitigation strategy

By evaluating the potential risk, you can better understand the main drivers of your risk and how much potential noise your business is exposed to, given its size and profile. Comparing your potential risk to your program objectives can help drive a clear strategy to implement for risk mitigation. As you answer these questions, it will lead to key decisions you must make when starting to manage FX risk or improving your current strategy.

Flexibility

A key question to address is where your program falls on the continuum of risk management strategies, from programmatic to flexible. A programmatic strategy will have more prescriptive hedge ratios, timing, and products. It is usually easier to implement and manage because you make most of the major decisions ahead of time, and your team needs only to operate within those parameters. The biggest drawback is the strategy's lack of flexibility as conditions change.

The other end of the spectrum is a more flexible structure, where hedge ratios, tenors, and instruments may change based on the market or your strategy. This allows you to be more opportunistic, hedging as the market moves. However, it can be much harder to make operational, given the number of decisions you must make from month-to-month or quarter-to-quarter. Maintaining firm controls will be crucial since your team members will operate with greater discretion.

There is no best practice on the question of flexibility; however, with either approach, it is important to articulate the objectives to all stakeholders. This will address how much discretion the finance team has over the program and how those decisions contribute to your company’s overall strategy.

Communication

Once the objectives are clear, effectively communicating the results of your efforts is crucial. A common question is, “How do I show my program is working?” Having a clear, proactive communication plan prevents uncomfortable questions in the face of market volatility. This means having all the relevant data available to illustrate the financial results. It is difficult to communicate the results of a financial risk management strategy in a vacuum, so Chatham recommends showing how it is one part of the larger picture. It is important to design reports that show more than just the gain/loss on any hedges but also the impact of other areas of the business: revenue and expense forecasts versus actuals, currency breakdowns, etc. (See example below.)

By demonstrating the impact of each element of the results, you can assist stakeholders in better understanding the impact of the hedging program. Additionally, comparing forecasts to actuals shows how missed forecasts can cause further challenges.

Data systems

Creating these reports and communications highlights the need for data availability. Despite advanced technology, many companies still struggle to have all the necessary data at their fingertips. As your company grows, you may find yourselves using multiple systems across different businesses or geographies, making report and dashboard building a slow and laborious process.

Although there are no shortcuts to streamlining data, the results are often worth an investment. Implementing straight-through processing reduces time and significantly decreases the potential for human error. It allows you to be faster and more accurate. It also facilitates the creation of real-time dashboards that stakeholders can view whenever they want and wherever they are.

A theme we hear from many companies is “no surprises.” With real-time reporting, you can highlight potential sources of noise and risk before you reach month- or quarter-end. Instead of searching for the reason for volatility, you can identify it and respond to your management team with a strategy to move forward before the impacts hit your financials.

Questions to consider:

• Is data easily accessible?
• Is there straight-through processing?
• Are there appropriate dashboards to report in real-time?

How to move forward

Many strategies outlined here require strategic alignment across your business. At Chatham, we partner with many companies as they work through these challenges and will gladly discuss how we can support you in creating a successful financial risk management strategy.

Chatham Financial partners with financial teams to develop and execute financial risk management strategies that align with your 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 financial teams to develop, evaluate, and enhance their risk management and to articulate the costs and benefits of strategic decisions.