The challenge:

To improve its foreign exchange processes Larsen & Toubro was looking to insulate its imports in US dollar against the functional currency of the company, the Indian rupee (INR). Imports involved in the project were to the tune of US$150m that required insulation for possible devaluation of INR against the US dollar.

Larsen & Toubro were looking to optimise the cost of hedging the imports which was around 9% per annum. It also wanted to balance the risk reduction vis-à-vis hedge cost payoff by exploring both commercial as well as financial risk reduction solutions.

The solution:

The treasury team at Larsen & Toubro took on new dimensions by facilitating and structuring a critical hedge solution for the project. This enhanced role that treasury played in structuring this transaction was the result of years of efforts on multiple areas such as building the requisite commercial and risk management econometrics expertise as part of a bid advisory function in treasury, establishing a well-oiled business finance partnering channel and also building a knowledge base beyond financial risk management covering business knowledge and competitor intelligence.

In doing so the company avoided an overall impact due to forex variations to the extent of US$20m by factoring the potential depreciation of its functional INR and putting in place an optimal hedge solution. Subsequent depreciation of INR currency of around 20% (due to the headwinds that emanated out of the macro-economic risk arising out of US Fed’s announcement of a taper of its QE programme) was completely insulated due to the commercial solution that was implemented. Tail risks that actually materialised were fully clipped off in the project.

A cutting edge model which simulated the most optimal hedge solution given the risk tolerance levels in-built into the model reduced the project cost by US$20m by way of the reduced cost of hedging for the foreign exchange risks of approximately US$150m. The solution also tapped on the correlation benefits between currencies to optimise further on the cost of hedge.

Best practice and innovation:

In a high-value developmental metro project of the group, the solution brought in a unique forex risk architecture which optimised the payoff between risk reduction vis-à-vis the cost involved in putting in the risk insulation programme.

The solution that the company chose involved going well beyond accepted methods of foreign exchange insulation, such as hedging. Furthermore, the role of the treasury in structuring the business transaction was key, and was widely appreciated by many other parts of the business, not only because of the considerable cost savings it generated but also owing to the foresight the treasury function demonstrated in gauging a possible shift in the macro landscape.

The implemented solution was widely acknowledged as a cutting-edge answer to a critical financial risk that was facing the group as part of the project. The unconventional yet scientific approach taken to address the financial risks involved in the project make it a remarkable and unique solution. “The solution largely insulated the project from potential large currency depreciation moves while also optimising on the costs involved in putting in place a currency hedge framework,” says Vipul Chandra, Head – Treasury at Larsen & Toubro.