Commodity and interest rate risk hedging have long been the poor relations of the risk hedging world with corporates tending to focus more on mitigating their foreign exchange exposure.
According to Chatham Financial’s ‘State of Financial Risk Management’ report, only 47% of large US companies with interest rate risk are currently hedging it, compared to 61% of companies with foreign currency exposure. This is despite more than three quarters of the companies surveyed (78%) having exposure to interest rate movements, making it the most common financial risk.
This disparity is partly a legacy of more than a decade of low interest rates, with some CFOs having never worked in a higher rate environment. And as Helen Kane, Risk & Exposure Fellow at Hedge Trackers points out, companies with interest rate hedge programmes that fixed their interest expense have generally lost money over the last 15 years.
“Failure to manage currency risk shows up in two places, one of which is a line that screams ‘FX gain/loss’ to analysts who then ask questions, and the second of which is hidden in the operating margin,” she says. “For obvious reasons, corporates are most likely to hedge the line called FX gain/loss.”
According to Kane, those without hedges on some amount of their debt – as well as those unfortunate enough to have their only hedges maturing in the current environment – will soon be responding to ‘why aren’t you hedging’ and ‘what is your hedge strategy’ questions from analysts as the interest expense line starts screaming for attention.
Very low rates for a very long time coupled with the introduction of central bank forward guidance supported progressive complacency suggests Francesco Podesta, Head of Interest Rates at risk management consultancy firm Audere Solutions.
“Directors who decided not to hedge in the past started to believe they could predict when rates would begin rising,” he says.
Chatham Financial Managing Partner and Chairman, Amol Dhargalkar, refers to an increase in the number of companies hedging their risk even after rates had increased. “Last year and into 2023 we have seen record demand by both public and private companies in hedging their interest rate risk and searching for strategies that could lower interest expense,” he adds.
Most floating rates across developed markets are higher than the fixed rates that can be achieved through swaps, which has encouraged companies that don’t believe the drop in rates will be as fast as the market projects to maintain a favourable stance towards fixing their floating rates.
“At the same time, in most cases when prices are high, having the possibility to benefit from lower rates can be advantageous – especially when the hedging horizon is long (four-plus years) and many uncertain factors still need to play out,” says Podesta.
Pam Sullivan is Treasurer at Massachusetts-based IT company Virtusa. She explains that the company’s primary reason for implementing an interest rate hedging programme was predictability of expenses and cash flows.
“We also chose products that allowed us to do this with zero upfront costs,” she says. “Since we also want to be able to take advantage of a lower interest rate market, we targeted to have ~50% of our debt tied to fixed rates. In the current economic environment we are saving on interest expenses, as rates have quickly risen above our hedged rate.”
Erik Smolders, a Deloitte Risk & Financial Advisory Managing Director in treasury management says organisations need to decide which interest rate profile matches their business best, be it fully floating, fully fixed, or a combination of fixed and floating.
“By managing their debt instruments to arrive at a fixed versus floating profile that fits with their business needs, organisations have the ability to make adjustments through interest rate derivatives if the ideal ratio cannot be achieved by debt instruments alone,” he says.