Hedging foreign exchange risk, a strategic challenge for companies active in international markets (3/3)
How can you implement a customized foreign exchange hedging strategy?
As we highlighted in our previous articles, unmanaged FX risk can cause significant fluctuations in the earnings of a company and may threaten the company’s viability. In the context of a comprehensive FX policy framework at Group level, treasurers and CFOs can monitor the impact of foreign exchange fluctuations by calibrating their hedging model with different tools.
In order to implement customized foreign exchange hedging, treasurers and CFOs may use 2 categories of levers:
Internal hedging techniques such as:
- Invoicing in a preferred currency (not always possible for currencies with limited convertibility);
- Including currency risk-sharing clauses in contracts with commercial counterparts; or
- Considering cash flows at group level and at subsidiary level in order to take advantage of counterbalancing effects between incoming and outgoing cash flows in a same currency;
A wide range of financial instruments available on the financial markets such as:
- FX forwards: They lock the exchange rate of known future cash flows.
- FX options: They act as an insurance guaranteeing a minimum / maximum exchange rate for a period of time.
- Structured Products: Tailor-made, they can address specific hedging needs while keeping costs low, usually leaving some risks not hedged.
The pros and cons specific to each of these solutions need to be considered before setting up an optimal hedging strategy, being of course different from one company to the other based on its business model, risk profile, strategic environment position and financial proficiency. By nature, FX risk cannot be perfectly hedged due to limited scope in time and reliance on business forecasts.
It is very important to keep in mind that foreign exchange hedging is not speculative, the goal is to minimize P&L volatility and secure future cash flows. FX risk management must become an integral part of a business, from cash flow management to strategy. Implementing an appropriate hedging strategy provides a clear competitive advantage but it requires method, cultural change and some help.
Based on this observation and discussions with our corporate partners, Décision Performance Conseil and DPC Asia Ltd have compiled a modular offer to support CEOs and CFOs in the definition and the implementation of a foreign exchange hedging policy thanks to a simple and pragmatic approach:
- We will start with the assessment of the FX exposure of your company. After gathering all relevant business & financial data to reconstruct an informed Financial Model tailored to your foreign exchange exposure pool, we will design a currency-centric Business Forecast model based on your current assumptions for the year to come. We will run rational, reasonable FX scenarios for the year to come based on extensive FX market expertise. You will be provided with the current exposure for each currency and actionable Forecast Scenario Matrices at a one-year horizon.
- Then, we will assist you in understanding the different FX management scenarios with trainings on hedging instruments and non-financial hedging strategies, on our FX management tool and its functionalities. We will also train your accountants, explaining to them the impact of hedging products on their accounting.
- Finally, we will support you in implementing the hedging strategy with continued follow-up. In order to ensure permanent monitoring of foreign exchange risk, we will advise you on relevant system solutions and possible organizational changes in FX management. A currency risk policy will be defined and shared within the company.
Naturally, said approach is to be further refined depending on the maturity and needs of each company regarding FX problematics.
Why us? DPC Asia will help you tackle FX risk exposure and add value to your business thanks to:
- Our in-depth expertise of foreign exchange risk management and performance monitoring;
- Our objective and unbiased advice, to accompany you towards your targets;
- Our transparent and pragmatic approach.
Please feel free to contact us for a preliminary assessment of your foreign exchange exposure, we will be more than happy to assist you with your enquiries.