FX strategy at Takeda, Asia’s largest pharmaceutical group, has continued as normal throughout the currency volatility caused by the pandemic. The company’s balance sheet FX hedging programme and net investment hedge scheme sees it hedge against the month-end rate, forecasting and rolling its FX exposure forward, explains Assistant Treasurer, Financial Risk Management, Urs Berger, speaking from the Japanese company’s Zurich base.
Key risks in the strategy include any sudden shortage in liquidity, or the market rates fluctuating the day month end falls or the following day, when the company readjusts its positions after month end. Despite a spike in both those risks back in March, the company didn’t deviate from a core strategy specifically structured to protect its P&L from currency fluctuations and just the kind of background financial turmoil that hit in March.
“We use a systematic approach because it makes the economic situation largely irrelevant,” says Berger, adding that the company is currently exploring ways to develop the strategy further by hedging currency risk on future cash flows not yet recorded on the balance sheet. “Such a hedging programme would only cover highly probable cash flows where the company can apply hedge accounting, but it is the latest innovation in strategy at the firm,” he says.
What has been relatively seamless for Takeda has proved more challenging for other companies, however. Many corporates exposed to supposedly risk-free, developed market currencies during the early weeks of the pandemic, have found currency moves have eaten into their profit margins and combined with illiquidity in a perfect storm. It has shaken many companies out of an enduring belief that currency volatility won’t affect them, and that they don’t require hedging programmes.
Others, where managing FX risk came below other immediate priorities like looking after staff and managing liquidity, also found themselves exposed. With more currency storms approaching as the markets prices in big swings in exchange rates around the US presidential election and Brexit transition, recently burnt companies are seeing FX risk in a new light.
In the Nordics it’s sparked a new interest from corporates who either didn’t hedge or had very low hedging ratios prior to the pandemic, based on a belief that trading conditions in the region had, and therefore always would be, benign. Not so now following the Norwegian kroner shedding nearly 30% of its value against the dollar in March triggered by the pandemic and collapse in oil prices. “Many corporates in the region didn’t have hedging policies, especially against neighbouring countries. Now we are seeing more treasury teams look to safeguard the company against currency volatility and concentrate on their core business. They want to remove the headache of volatility that can quickly become a migraine,” says Jesper Bargmann, Head of FX Sales at Nordea in Copenhagen.
For companies with hedging policies in place, the response is more nuanced. Rather than increasing their hedging ratios, many have adopted a wait and see approach. Although treasury teams know they will have to buy and sell currency next year, few have the confidence or certainty in forecasts to commit to hedging all that risk at this stage. “Clients who have always hedged 18-months ahead may be hedging more like 12-15 months ahead. A client who always used a hedge ratio of 75% may now be using a hedge ratio of 50%. Extrapolating from 2018 and 2019 flows doesn’t mean much when the world has been turned on its head,” explains Jonathan Pryor, Head of FX Sales at Investec.
The problem with the COVID crisis is rooted in companies’ inability to predict their future cash flows – even for the next three months. “Hedging every order is impossible if you don’t know your future income or expenses,” says Nordea’s Bargmann, who says companies are hunting for more flexible strategies that combine a typical forward contract with options (and the right to fulfil contracts or not) for greater flexibility.
Although companies still want products that give them a guaranteed hedge, they also want an element of flexibility when it comes to the amount they want to buy, agrees Investec’s Pryor. “A lot of the work we’ve done with clients is around providing them with zero premium solutions given guaranteed hedges with an element of flexibility.”
In other trends, banking experts observe heightened interest amongst corporate clients in the macro drivers and economic factors that move markets – especially amongst those without comprehensive hedging strategies in place. “People are watching inflation, GDP and employment figures like hawks,” says Pryor. Although volatility has fallen, currencies remain jumpy, especially if the market considers a government’s response to the pandemic wrong around, say, lockdown rules or the amount of stimulus, opening-up the risk of a sell-off. A particular concern at Takeda is US inflation, where any spike might impact interest rates, says Berger. “If they increase the interest rate, we will have higher costs of carry and higher hedging costs,” he says.
Market volatility and spikes in pricing have also shone a spotlight on corporates’ banking relationships. At Takeda, where the balance sheet hedging programme is currently augmented by additional hedging exposures because of Takeda’s ongoing acquisition of Shire, banking partners’ ability to hedge in a short period of time has been key. “We placed big orders in a short period of time,” says Berger. “Banks might not always be able to quote because they have their own counterparty risk exposures.”
A diverse number of counterparties as opposed to relying on specific banking partners has proved invaluable. “We trade via automated trading platform FXall with many FX banks and can therefore diversify counterparty and liquidity risks, as well as ensuring best price execution,” he says. “In times of high FX volatility we expect our banks to enable liquid trading volumes at the best price.”
That said, the cost of hedging has fallen since the peak of the pandemic and implied volatility is at low levels. “We have a market that feels so fragile and volatile, but still, a six month option doesn’t currently cost that much,” says Investec’s Pryor.
Elsewhere, experts note increased demand amongst some corporates to hedge emerging market currency risk. Although many companies active in emerging markets are volatility veterans with clear strategies in place, others were left exposed. The crisis proved that emerging market currencies can move a lot more than the majors from a percentage perspective. “Emerging market currencies can move so quickly that even relatively small exposures matter – sometimes more so than larger exposures to stable currencies,” says Investec’s Pryor.
Demand for automated strategies could also get a boost from the pandemic. FX has always been at the forefront of automation, mostly between the interbank market and brokers. In one trend, more small Nordic treasury teams without dedicated members of staff looking at FX are exploring automated FX payment and clearing of currency balances, as well as automating liquidity swaps. “Rules based automated hedging is new in the market and a very interesting development within next Gen FX,” says Nordea’s Jesper. Under these solutions, software speaks to a customer’s ERPs (Enterprise Resource Planning System) to define a hedging policy from the order book, hedge and then execute trades with chosen banks.
He cautions, however, that rigid automated strategies based around a fixed hedge profile don’t necessarily fit the changed corporate landscape and new pandemic-induced factors driving underlying business strategy. Automated strategies offer the most compelling solutions viewed on their own merits in the context of the markets. “The number of FX transactions is huge, so if companies can automate it to run in the background, they can stop worrying and also eliminate operational risk. It’s like a self-driving car – you may feel safer in this than driving with your friends,” he concludes.