Insight & Analysis

Ignoring FX risk will not make it go away

Ostrich burying it's head in the sand, ignoring what's going on around it

The current environment for FX management for corporate treasurers is challenging to say the least. We look at the main drivers and the risks and opportunities potentially emerging from this environment.

With escalating geopolitical tensions between Washington and Beijing, and rising uncertainty over Brexit, the current environment for FX management is unpredictable and volatile. And certainly, politically charged. One of the main challenges for corporate treasurers in the current landscape is maintaining visibility and access to as much data and insight on market moves as possible.

Being able to do this will give corporate treasurers a clearer picture of their company’s position in terms of cash liquidity, currency exposure, payments efficiency and other risks, says Jim Warner, Director of Operations at Centtrip, a global payments, treasury and FX fintech. It will also enable them to make more informed strategic decisions at all levels, not just by the management team and board members, when it comes to leading the company forward.

“Knowing that treasurers still tend to use manual methods, such as spreadsheets, to perform basic activities, the introduction of technology for automation and integration methods offers a number of benefits, including increased visibility and control,” he explains. “Using a single platform, such as a treasury management system (TMS), that is either linked to or integrated with other programmes, enables treasurers to have a panoramic view across all parts of treasury operations and to even connect with colleagues from different departments.

Biggest risk

It’s as well to attend to this issue because as a day-to-day strategic challenge, FX volatility ranks way up the list for most corporate treasurers versus, for example, cash visibility, liquidity or cash repatriation. Warner places it ahead of all.

“FX volatility is usually the top of the list, especially in the current political environment when mitigating risks surrounding the currency market is very topical and key,” he comments. “After that comes the importance of protecting profits and ensuring reliable cash flow, especially if you are an SME that is running a lean operation.”

Given the effect that FX movements can have not only on cash flows, but also financial results (even the household names like Diageo, Unilever and Facebook are not immune to those), mitigating FX risks is fundamental for treasurers.

Corporate treasurers use hedging strategies, such as forward contracts, to safeguard against potential downward movements in future exchange rates, as well as to participate in the upside. “Even in the current state of uncertainty for currency markets, companies are trading more currency than ever before,” notes Warner.

However, he adds that the amounts used for hedging have “fallen substantially”. Furthermore, not only are these corporates choosing not to hedge but, when they are hedging, they are doing so for shorter periods of time.

Technology is undoubtedly revolutionising corporate treasury, Warner continues. “As businesses are looking to better understand and anticipate market moves, as well as to devise and implement a risk management strategy, treasurers can and should use the new – and often better – tools available to them to ride out political turmoil.”

Balanced approach

Given the impact of current FX challenges, it’s important to define experienced market professionals that corporate treasurers can bounce ideas off. But it is also important to consider technology that allows treasury to execute transactions in a timely fashion, at the best possible rate. Either way, decisive balanced action is called for.

“Not to hedge against FX volatility risk is to speculate,” believes Warner. “The most risk-averse solution is to back an order against an FX contract to protect the pricing. Some people try to play with FX as a revenue stream, to speculate and try to increase their profit margin rather than to remove risk. Ultimately, FX volatility should be viewed as a risk.”

However, in his work in this space, Warner says he has observed many abstaining from the market altogether in some cases. “They have sat on their hands, which is evident in M&A and real estate.”

Planning ahead

The kind of action plan Warner recommends would see the treasurer considering the following.

  • Simplifying the bank account structure.

  • Freeing up time and liquidity through automation.

  • Breaking down treasury costs.

  • Maximising use of hedging tools and leveraging fintech.

“Surprisingly, almost one-third of businesses still believe high street banks offer a competitive exchange rate, while nearly a quarter do not consider a specialist fintech company as a cheaper alternative,” he comments. As a result, he feels many businesses “are missing out on significant savings and solving operational inefficiencies”.

However it is tackled, current FX volatility should not be ignored because it there is little sign that it is about to go away any time soon.

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