Best Foreign Exchange Solution Winner: Cochlear Ltd
Published: Feb 2019
Photo of Swee Sun Tay, HSBC collects the award on behalf of Cochlear Ltd.
This solution makes use of advanced risk management techniques such as CfaR and VaR which also link directly to the risk appetite of the company’s board in order to determine appropriate currencies to hedge and how much to hedge. FX risk management is now much more aligned with the company’s risk appetite.
Dane Birdseye
Group Treasurer
Sydney, Australia
Cochlear, formed in 1981 and based in Sydney, is a medical device company that designs, manufactures and supplies the Nucleus cochlear implant, the Hybrid electro-acoustic implant and the Baha bone conduction implant.
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CFaR and VaR links risk appetite of board for this ‘Efficient Frontier’ FX solution
The challenge
A review of the FX risk management policy had not been undertaken by Cochlear Ltd in many years, with the previous policy being developed in 2010 when the company was quite different.
The formulation of the strategy was to answer the why, what and how of foreign exchange hedging for the company going forward.
The solution
Cochlear set about a review of their foreign exchange risk management policy by identifying the sources of foreign exchange transaction exposures as follows:
Purchases/sales of goods and services in a foreign currency (non-functional currency) to offshore subsidiaries.
Purchases of capital equipment priced in foreign currency (non-functional currency).
HSBC Bank performed an analysis of Cochlear Ltd’s foreign currency portfolio in order to determine the efficiency of the proposed hedging strategy. The Efficient Frontier considers the cost of hedging compared to the value at risk (VaR). The new hedging strategy improved the efficiency of the currency portfolio to a more optimal position along the Frontier.
Policy/strategy
FX hedging strategy
Risk appetite
Risk management linked to risk appetite
Period of hedging and currencies
Three years for net revenue12 months for net expenses
Hedging approach
‘Rolling and layered hedge’
Hedge products
FX forwards and options
Best practice and innovation
The main innovative concepts from this hedging strategy were as follows:
The risk management strategy was linked to risk appetite of the board and based on in depth analysis of the risk exposure using cash flow at risk (CFaR) and VaR.
Use of CFaR and VaR measurement techniques in order to determine appropriate currencies to hedge and also hedge policy levels to achieve an efficient frontier for hedging.
Determining appropriate circumstances for the use of different hedging products. Forward exchange contracts (FEC’s) are the main hedging instrument up to the minimum hedge levels and then FX options may be used to hedge between the minimum and maximum hedge levels. This provides protection while improving flexibility to allow for differences in timing and amounts of expected cash flows as well as the ability to benefit from more advantageous exchange rates on this portion of the exposure.
Winning this award is a great recognition for Cochlear’s prudent approach to risk management and is an acknowledgment to the treasury team and also to HSBC for the work done in conducting the analysis of FX risk, in order to arrive at an appropriate strategy.
– Dane Birdseye, Group Treasurer
Key benefits
A CFaR measure was used to determine the potential impact on cash flows and therefore earnings per share from volatility in the currencies that the group has exposure to. From this analysis, the strategy recommended was to hedge currencies with a CFaR exposure of greater than AUD2m pa. This resulted in reducing CFaR exposure from an unhedged CFaR of AUD77m pa down to AUD6m pa.
VaR was reduced from a potential loss of A$59m pa to a gain of A$2.5m pa (due to favourable forward points at the time) based on hedging along the efficient frontier.
“The solution makes use of advanced risk management techniques such as CFaR and VaR which also linked directly to the risk appetite of our board in order to determine appropriate currencies to hedge and how much to hedge. The strategy is dynamic in that it allows for new currency pairs to come into the hedge policy automatically or other currencies to stop being hedged, based on the key trigger level of CFaR greater than AUD2m pa per currency pair,” concludes Dane Birdseye, Group Treasurer.
Key learning points
Regularly review and update existing policies to ensure that they reflect the current financial risks of the business.
Align risk management approach with the risk appetite of the board. This answers the question ‘why hedge?’.
Conduct risk analysis, such as CFaR or VaR, to provide the empirical evidence that supports your risk management strategy. This answers the question of ‘what to hedge?’.
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