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Managing Corporate FX Risk

Spoke to Eleanor Hill from FX-MM magazine about the challenges of managing foreign exchange risk today. Published on FX-MM Magazine on June/July 2011 issue.

Five corporate treasurers discuss the challenges of managing foreign exchange risk today, putting forward some interesting suggestions as to how to tackle operational and execution risk through the use of a multi-bank FX portal for example. Talk also turns to the selection of competitive banking partners and even hybrid cash pools.

Best practice and risk: two topics that are of ever increasing significance to corporate treasurers, in particular where foreign exchange is concerned. As a result of this intensified focus on FX, over the last decade, we have witnessed the rise of a new role within corporate treasury departments, namely the treasury trader. While a handful of corporations have appointed new personnel specifically dedicated to that task, some have shared the role among existing treasury employees and others are currently contemplating the most appropriate path to take. 

Choosing the correct staffing approach to managing FX risk is only one piece of the puzzle however – one that is closely linked to having the right technology in place. After all, devising an effective strategy for mitigating FX risk, in particular those risks associated with execution, consists not only of ensuring that the company achieves the best price possible, but also having technology in place that facilitates an efficient middle office function. In turn, this will help to reduce trading and processing costs, as well as the risk of costly errors, as our corporate panel explains.

EH (FX-MM): What are the main challenges that you face in FX risk management today?

MK (Indesit): For us, I would say the main challenge – certainly over the last two years – has been volatility. As such, hedging is a top priority for us. Here at Indesit we do not use derivatives for this, as we believe there are simpler instruments that can be used. Nevertheless, the simpler instruments require more frequent attention in order to cope with the levels of volatility. Like most manufacturing companies, we don’t want to experience any material P&L effect of the volatility on the balance sheet, so we have been taking a more proactive approach towards identifying and mitigating FX risk. This is particularly important for us as we are working in multiple currencies, with one of our biggest markets aside from the Euro market being the UK and another being Russia. In addition, our production centres are based in other countries such as Poland and we buy components priced mainly in USD and EUR.

JT (AkzoNobel): There is a split in the way that we manage our FX risk. We have the day-to-day risks that are associated with mainly managing payables and receivables in different currencies for example and then we have the risks that come with more long-term strategic investments.

SB (BAT): Our objectives with regard to FX risk management remain the same – avoiding volatility in our eps to support our eps growth objective. An increasing exposure to emerging markets and volatility in the developed markets through the financial 'crisis' has made achieving this objective more challenging, especially with the high cost of hedging some of these exposures.

MK (Panalpina): I agree. At Panalpina, the main challenge is really the hedging cost. For example, with the high yielding currencies, such as the Brazilian real, where you have an interest differential of say 11% against the US dollar, the question is whether or not we should hedge, since there is a huge price tag attached to it. So what we do is to analyse the high yielding currencies and ask whether it makes sense to hedge. Essentially, what is the risk if we hedge and how does it compare if we don’t hedge? We review our positions on a monthly basis in a risk committee meeting.

GB (GE Oil & Gas): Speaking more generally about challenges, globalisation and the economic crisis in the developed countries meant that corporations started to do business in countries, and with customers, that are often highly regulated, where the markets aren’t liquid and counterparty risk is higher. Onshore hedging practices or NDFs have become increasingly necessary, leading to complexity in derivatives management on the accounting side, as well as in the tax treatment across the legal entities involved. 

EH (FX-MM): How do you manage these challenges and related risks?

GB (GE Oil & Gas): As I mentioned, globalisation was the growth engine at the beginning of the millennium, then the economic and financial crises in developed economies challenged corporates to reach outside of their comfort zone, ie to sell to developing countries where initially they were just buying at lower prices (but also at a lower quality level).

The ever more complex environment led us to add resources in our HQ CoE (Centre of Excellence) and then to identify specific regions/areas where our exposure was so material that local skilled resources were needed as well. This was coupled with an enhancement of the technical platforms that we use for managing FX exposure identification, hedging, accounting and reporting.

JT (AkzoNobel): Likewise, in order to better manage our operational flows, we use an electronic trading platform, which allows us to achieve straight through processing (STP). Moreover, the possibility to trade real-time with multiple banks (price tension) is an important value driver behind the platform. Since the value of the currencies that we trade on a daily basis is not that significant, and the tenors are not that difficult to trade, it really is much simpler for us to execute our FX deals directly and electronically.

SB (BAT): The key for BAT was to ensure we have a full, central view of all FX risks, to identify which FX risks are hedgeable from an accounting perspective and to then ensure we manage the risks as efficiently and effectively possible. This has led to the rollout of a new cashflow reporting tool, greater central control of FX risk decision  making, and consequent changes to our Treasury people structure.

MK (Indesit): As a company, we are very focused on our exposures across commodities, price and currencies. Over the last two years we have been working on eliminating those exposures as much as possible. We built a hybrid pooling instrument which allowed us to notionally pool many different currencies without changing ownership of them. This hybrid solution means that treasury can overdraw in the currency of their choice; it eliminates inter-company loans while creating a new funding vehicle and it also reduces or eliminates FX and swap transactions to offset the debit positions of the accounts. This is just one example of how we have been more actively addressing our FX risk.

EH (FX-MM): Do you always trade FX electronically?What are the reasons behind this?

JT (AkzoNobel): The electronic trading platform has been running ‘full throttle’ for around one and a half years at AkzoNobel. We opted for such a solution as we felt that manual trading was leaving significant margin for error and, ultimately, putting the company at a strategic disadvantage. We are constantly striving to have better operational processes in place and the STP benefits, together with additional functionalities that the portal offered, such as reporting, meant that the decision to implement an electronic trading platform was really a no-brainer.

That said, for the FX trades that are a little more exotic or niche, we will still pick up the phone to our banks and conduct a one-to-one trade.

SB (BAT): Our Treasury Service Centre (TSC), which accounts for most of BAT's external trades, has for some while had the objective of trading 100% through non bank proprietary electronic platforms. We currently use two platforms, including FXall. This is to ensure dealing transparency, capture pricing benefits, the data benefits and straight through processing that we can achieve.

MK (Panalpina): Whenever possible we trade electronically, I would say that 95% of trading is done on platforms. The deals that we still do manually are those which are a little more delicate or niche – such as certain currencies which only can be traded via NDF. The main reason why we trade electronically is that we seek straight through processing. When a trade has been carried out electronically, we can log it in our Treasury Management System (TMS) with as little manual intervention as possible.

GB (GE Oil & Gas): Yes, we also always try to trade electronically. However, we do so using a GE-built multibank portal which is run by GE Corporate Treasury. All GE businesses enter their hedging and spot trade requests into the portal and they are executed by Corporate Treasury with a panel of banks in a competitive environment. Results are made available to the businesses on another functionality of the same platform, allowing the business to download the data into their accounting systems and ledgers.

MK (Indesit): On the trading side, we still operate very manually. We do not currently trade FX electronically, even though we have centralised many of our activities. We will certainly move to trading FX electronically going forward, but we have not made a decision yet as to which platform would be best suited. This is really something that we need to decide during the course of the year.

What I like about the vendor platforms is that they really cater for the corporate’s needs and the banks have traditionally tended to be less inventive in the FX space. Also, I believe it’s important to have a platform that is independent.

EH (FX-MM): What advice would you give to other treasurers who are thinking about using an FX portal? 

JT (AkzoNobel): One of the main pointers I can give is to ensure that the company has the right infrastructure in place behind the scenes to reap all the benefits that an FX platform can bring. When we implemented FXall, we in fact did a complete roll out of a new TMS at the same time. Having our system up-to-date ensured that  the processing of orders was as efficient and as straight through as possible. I’d also urge people to look beyond the immediate processing benefits and to broaden their thinking to the strategic pros of using an FX portal. For example, since the portal brings together a number of banks, it actually serves as a great analytical tool. By using the portal, we have been able to identify which banks are strongest in which currencies and tenor pockets. As a result, we have been able to select a really competitive group of banking partners with whom we regularly do business via the portal.

EH (FX-MM): Where do you see the future of FX portals?

JT (AkzoNobel): With the benefits we discussed above, I’m sure such platforms will continue to rise in popularity. However, I believe that these platforms will also need to evolve further in order to continue to meet the needs of increasingly sophisticated users. Corporates are continuing to expand into emerging economies and this often calls for a different type of currency trading – NDFs being a prime example. Elsewhere, I would say that algo trading of FX is also a growing trend that portal providers should keep an eye on.

MK (Panalpina): Absolutely. Going forward, I also believe that treasury departments will be looking for a multibank platform where they can trade and confirm all the products that they need (FX, FX options, deposits, money market funds, commodities etc) on a daily basis. 

Looking to the future

As this panel discussion has highlighted, a changing global economy is placing unprecedented demands on corporations to improve the efficiency, performance and compliance of their foreign exchange trading. Against a backdrop of volatile markets, regulatory changes and increasingly complex multi-currency transaction chains, corporates may feel at a loss to know where to begin when looking to instigate best practice techniques in their FX risk management. It is no surprise, therefore that a growing number of corporates, large and small, are turning to strategic partners to assist them in optimising their day-to-day FX operations. Mark Warms, General Manager, EMEA, FXall, comments: “Achieving the best price through best execution is an absolute must for today’s treasurer. In these times of austerity, marginal savings really can be ‘make or break’ where a company’s bottom line is concerned.”

“Elsewhere, given the ever expanding responsi - bilities that the treasurer is undertaking post-crisis, automation can not only help to save money, but also that precious commodity: time,” continues Warms. Multi-bank FX trading platforms are a working example of such savings as they effectively remove the need for telephoning multiple banks for FX quotes, whilst also taking care of best execution and compliance, as well as offering such functionality as analysis of best execution. Moreover, the resources required to implement a multibank FX portal are relatively minimal.

Nevertheless, Warms is keen to point out that multibank FX portals are not a replacement for bank relationships, but a complement to them. “FXall offers real-time access to the expertise of your bank salesperson through instantaneous chat and shared views,” he explains. “FXall is integrated with more than 80 of the world’s leading foreign exchange market makers and offers clients the opportunity to fully leverage the potential of their bank relationships, as Jarno in fact pointed out during the debate.” In summary, multi-bank FX portals have earned their place as part of a comprehensive approach to the optimal management of corporate FX and the associated operational and execution risks. As such, not only is the portal space one for treasurers to watch, it’s a space to get involved in.

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