On the Constellation Brands’ Q126 earnings call, CFO Garth Hankinson mentioned that the company’s hedging programme starts roughly three years before each financial year and enables it to ‘smooth the impact’ of currency risk from year to year. This represented an unusually explicit acknowledgement that stabilising financial performance is an important objective of corporate hedging programmes.

He is not the first senior financial executive to connect FX hedging with a smoother operating performance profile, although the stated aim is usually operational stability rather than managing accounting earnings to meet an analyst target.

“Investors increasingly value predictability, so reducing unnecessary volatility is an important objective,” says Alex Ashby, Group Treasurer at WPP. “The distinction is that treasury should smooth and manage risk, not manufacture outcomes.”

The objective is not to manufacture a particular earnings result but to reduce the extent to which reported performance is at the mercy of currency markets. This allows the underlying operating performance to come through more clearly.

“Investors often punish surprises more than they punish a few basis points of hedging cost and CFOs have internalised that,” suggests Dory Malouf, Senior Director Global Business Value Advisory at Kyriba. “Hedging is still fundamentally risk control but the risk being controlled has broadened. It is not just cash flow at risk but also earnings credibility and predictability.”

Underlying exposures

One way of distinguishing between the two is to ask whether there is a genuine underlying exposure and whether the hedge is appropriately sized to that exposure.

If there is – and accounting considerations have influenced the structure of the hedge – that may simply represent competent execution. If the trade exists primarily to move a line in the P&L without an underlying economic exposure, that is something else entirely.

“The level of the conversation has moved from ‘are we hedged’ to ‘what does this do to reported earnings and what does it cost me to get there’,” says Ripple Treasury Managing Director Product & Quantitative Strategy, Farah Lotia. “Designation does not make a programme economically right, but it forces you to name the exposure in advance, which means a hedge cannot be reverse-engineered onto an earnings outcome after the fact.”

If the objective of hedging has expanded from protecting individual transactions to protecting the predictability of earnings and cash flow, the measures used to assess currency risk need to evolve accordingly.

That is why cash flow at risk is gaining ground alongside value at risk according to Jauffret Solignac, Global Head of Mid-Market for ION Treasury.

“Instead of telling the board what a portfolio of hedges is worth today, cash flow at risk answers the question the board actually asks: with our current hedges in place, how far could currency moves push next year’s operating cash flow below budget, at a given level of confidence?” he says. “For any exporter whose margins swing with the dollar, being able to say ‘our worst plausible currency hit is US$15m, down from US$40m unhedged’ is a very different conversation with investors or banks.”

Solignac reckons that kind of measure should be standard board reporting, adding that the goal isn’t to manage earnings but rather to give the board and investors fewer surprises.