“Corporates’ focus should be making money by selling goods rather than by trading currencies”
Interview #27 with Dan Wilson of Citi’s eFX Solutions
Here is this week’s new #CFOBrain interview with Dan Wilson of Citi’s eFX Solutions. Dan explores the changes in the way corporates approach FX Hedging, and describes some of the biggest challenge companies find during the life cycle of an FX hedge. Check out other pieces from Kantox’ interview series here.
Could you tell us a bit about your role at Citi and your background? How did you end up working at Citi’s eFX Solutions?
For the first part of my career I had a more traditional corporate salesperson role, i.e. more the execution side. This included helping large corporates with their day-to-day FX needs, forecasted cash-flow hedging and M&A activity. But as relationships developed I also started to advise on their FX hedging policy, looking at risk quantification, and trying to find efficiencies in their processes.
More recently I have started working in Citi’s eFX solutions team, whose focus is to help clients identify opportunities and risks relating to FX transactions and develop processes to automate their execution. Our team works in parallel with the traditional corporate sales team, but eFX works across the region, with a focus on pan-industry themes and solutions.
Hedging is an all-encompassing task. In our view, the value is not so much in executing at the best price but in capturing exposure data, analysing the performance of your hedging strategy, reconciling, etc. At what point do you think firms should really jump into hedging and dedicate specific resources?
Companies should start thinking about FX risk as soon as their business starts doing cross-border trade — the earlier the better. Many companies incorrectly think they are not exposed to FX risk when they are paying their supplier in local currency. However, many times this means that they are simply adding hidden extra costs to their business. Why? Because the supplier they are buying from adds in an extra margin to account for the FX they are doing on your behalf. Citi and Kantox have worked with clients to combat this, offering new tools which can be the enablers for a shift to local currency invoicing.
Do companies still see FX Hedging as a trading opportunity?
Some still do. But their focus should be to make money by selling their goods, not by taking advantage of currency moves. They should have a rules-based approach to their hedging strategy, which means setting business rules in line with the goals of their business (but having the flexibility and boundaries around them) that dictate how and when companies execute their FX.
These rules need to factor in variations such as market moves, regulatory changes, changes in business forecasts, but they should also be able to vary the hedging strategy depending on if a currency is over or undervalued at a particular time. If a currency is overvalued, you may want to backload your hedging strategy, whereas if a currency is undervalued, you may want to frontload it.
FX Execution has been traditionally the core of FX Hedging. How has this changed?
The life cycle of an FX hedge involves identifying the exposure, applying the hedging policy, executing the FX hedge, tracking the hedge over the course of its life to maturity. The actual execution of the FX used to be a key point of an FX transaction, but now it is just an output of the process.
And what are the more challenging parts nowadays?
The biggest challenge companies have is identifying these exposures and capturing the exposure data. Many of today’s exposure management solutions largely rely on manual data entry from excel spreadsheets, which means that once the data is entered, if something changes in the business the treasurer needs to update these exposures.
If you think of a corporate treasury who has 20 subsidiaries around the world, who on a monthly basis ask these subsidiaries for their next quarter forecast, they will very likely receive the data as an excel spreadsheet. Reconciling these excel spreadsheets into one is a very inaccurate and a time-consuming process.
Companies need help in carrying out this process so that their Treasury Management System (TMS) can not only identify, capture, execute and track the FX exposure, but also evaluate its performance and use that intelligence to feed it back into new hedging decisions.
Is the lack of technology from the client side a problem?
Not anymore. Fortunately, there has been a lot of progress in corporate treasury in the last few years. Actually, I would say the problem is more the lack of time and lack of resources, especially after the number of people in finance departments has reduced in recent years.
Nowadays, reconciliation and reporting of FX hedging activity are very important to management and to shareholders but they are very time-consuming as well. This reporting should be aligned with the hedging strategy goals and to go beyond stating for example ”we lost 10% due to FX this year”, and to explain what was the evolution of that FX gain and loss over the year.
Why is understanding the FX exposure so important?
Businesses should understand what is true FX exposure that would really affect the performance of their business, and what is payments related FX. Payment FX are transactions that the business needs to do, but their associated exposure is so small that it just creates noise. There could be many thousands of tiny payment related FX transactions and in order to obtain good pricing, a client may decide to do an FX and a payment when really it should be a cross-border payment.
We see clients spending a lot of time in payment related FX, when really what they should be doing is automating that piece of the process, to free up their time to focus on the larger exposures which really affect their business.
What about the high-volume economy type of companies (think e-commerce, online travel, digital advertising)? What challenges arise for firms trying to develop a hedging strategy in that context?
What we tend to see within these high-volume clients (e.g. the UBERs of the world) is that they grow and expand much faster than companies in the past. This focus on growth could make them forget about FX exposure until they realize they are losing revenue due to FX volatility in some of the new countries they entered.
These sort of digital companies often work on a commission model, where the piece that is really exposed to FX volatility is not the fixed cost, but the commission on top of it. This means that if there is a 5% commission and there is a 2,5% FX move (which is fairly common), this actually equates to a 50% drop in commission. Following this example, if the FX movement is more than a 5% move that week (which could happen) then you are actually losing money because the whole commission has been wiped out.
How technology may provide a solution for this kind of companies?
Both, Kantox and Citi, are examples of how new technology solutions can avoid the above-mentioned losses. To a great extent, this is due to the fact that technology allows companies to look at things at the micro level, i.e. adopt a micro-hedging strategy.
This could mean hedging line-by-line, transaction-by-transaction, but it could also be day-by-day. The good part of hedging this way is that it enables companies to remove the FX risk as quickly as possible, so they can be dynamic with their pricing to their customer.
Pricing dynamically is key in these low-margin environments.
Totally, since these high-frequency economies and markets are very competitive, and you, as a company, cannot afford that the competition sells more than you just because you are pricing on outdated FX rates. That’s why managing FX on a micro level is key.
Looking into the future. How do you see the global FX landscape moving forward?
The biggest trend we are seeing at the moment is the drive to treasury automation, which will help corporate treasuries that are under pressure both from a resources point of view, but also from a regulatory and audit standpoint. They need to demonstrate that they are providing a cost-effective, and independent service to shareholders. They can’t be seen to favour a particular bank, so they need to remain as independent as they can, and provide “best execution”.
Does providing “best execution” mean putting 5 banks competing on a multibank platform and picking the lowest price?
Not necessarily. In that sort of scenario, a treasurer will be picking the best price of these 5 banks, but where is the real FX market? If the market is 1.3160 but your five banks are at 1.3165 and you choose the lowest one, where are you trading compare to the real market?
Beyond the price, there are also other factors that are fed into the concept of best execution, for example, things like credit exposure to a particular bank. What is the mark-to-market of the existing positions that I have with this counterparty? Should I make an effort to have some offsetting position with this counterparty to reduce my mark-to-market risk?
How is Blockchain technology affecting the FX world?
It is great to see that people are moving on from cryptocurrency/bitcoin to the underlying blockchain technology, but I don’t really see how it would solve any of the FX directly related problems. However, what I consider really important is the shift from settlement cycles and batch processing to real-time processing.
Real-time processing will revolutionise the industry and make the customer experience better. Why is it that you can’t settle same-day AUD in New York when it is just some numbers moving from one account to another? Why can’t we track a payment to see where funds are at any point in time? This seems very archaic to me, especially since the rest of the world is becoming more instant, from Amazon Prime delivering products at home in two hours, to music streaming and emails.
Originally published at www.kantox.com on November 2, 2017.
