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 organization 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 your organization answers these questions, it will lead to key decisions you must make when starting a new FX hedging program or improving an existing one.

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 just needs 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 program where hedge ratios, tenors, and even products may change over the life of the program based on the market or your strategy. This allows your organization to be more opportunistic with its strategy, hedging as the market moves. However, it can be much harder to make operational, given the number of decisions you need to make from month to month or quarter to quarter. Maintaining strong controls will be crucial since your team members will operate with greater discretion.

There is no best practice on the question of flexibility, but the best-run programs clearly articulate the program's objectives to all stakeholders. This will address how much discretion treasury has over the program and how those decisions contribute to your company’s overall strategy.

Communication

Once the objectives of your program are clear, effectively communicating the results is crucial. A common question we hear is, “How do I show my program is working?” Having a clear, proactive communication plan in place prevents uncomfortable questions in the face of market volatility. This means having all the relevant data available to illustrate the financial results. It is very 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 for the hedging program.

Data systems

Creating these reports and communications highlights the need for data availability. Despite the advances in technology, many companies still struggle to have all the necessary data at their fingertips. As your organization 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. Creating as much straight-through processing as possible not only reduces time, it also significantly decreases the potential for human error. This allows your organization 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 this type of 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 of the strategies outlined here are straightforward, but require strategic alignment across your organization. At Chatham, we partner with many companies to work through these hurdles and will gladly discuss how we can support your organization in creating a successful financial risk management strategy.

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.