There has been considerable concern about currency volatility building over the last year. The weakening euro at the end of 2014 and early 2015, and the devaluation of RMB over three days in August 2015, were events that focused corporate minds on hedging possibilities that their companies perhaps had not previously considered in earnest. Last year also saw commodity prices plummet. Ensuing hedging strategies aimed at benefitting from such declines have tended to be industry – and often entity – specific. Chinese airlines, for instance, tend not to hedge fuel, giving rise to windfall gains compared to other airlines locked in at much higher rates. Unhedged airlines, however, are obviously susceptible to future increases in the price of oil if they remain unhedged.
Given the recent sea change for commodities and currencies, now might be a good time for corporates to revisit their hedging strategies. But such a review across Asia Inc is not necessarily evident from available information. When we help companies review hedging strategies, it is not uncommon to find that decisions are not aligned with the company’s claimed hedging objectives. Equally, a closer look at these strategies may reveal that they are only optimal at certain points in the range of commodity or currency rates. For example, the use of certain instruments might be a sound strategy when oil prices are low, but not further up the curve.
We often find there is also an element of commodity basis risk. Corporates often do not hedge their entire exposure – frequently on the grounds of availability of suitable instruments, a lack of clarity where they might uplift bunkers, or because the cost of a matching instrument is prohibitive.
Hedging strategies in currency markets can generally be split into two main areas: FX exposures arising from purchases/sales (‘trading’) and exposure to foreign currency debt. Historically, many Asian companies have not hedged, or (for those that have hedged) under-hedged their FX exposure from trading activities. In some cases, this was because they were actively taking a position on future currency movements. In others it was due to inadequate forecasting capabilities; if a corporate cannot reliably estimate the extent of their currency exposure in any period it is often prudent to scale back hedging activities. Those companies that have hedged tend to use simple instruments – swaps and forwards. We are, however, seeing more companies at least considering options-based products, particularly those dealing with RMB.
Finally, in 2016, we hope to see a slight change in the mind-set of some companies, typically those new to hedging. These companies tend to view the success of their hedging based on whether or not they achieved a better rate. Instead, treasurers need to measure their hedging strategies based on whether it achieved their objectives, regardless of whether a hedge ‘won’ or ‘lost’. For example, did they ‘fix’ their cash flows successfully, so they had certainty? There is a lot that can be done to manage ongoing volatility; it’s largely a question of making sure decisions made in the name of risk management are being made for the right reasons.