Risk Management

Navigating the new risk landscape

Published: Sep 2022

From soaring inflation to FX volatility, today’s risk management environment is challenging companies in a variety of ways. So how can companies address these pressures, and what are treasurers doing to adjust their hedging strategies to the current landscape?

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More than two years since the pandemic began, the risk management landscape remains challenging. From record levels of inflation to the Russia-Ukraine conflict, a whole new set of issues is looming large for companies around the world. So what risks – and opportunities – should treasurers be aware of, and how are treasury teams adjusting their hedging strategies to meet the demands of today’s environment?

Overturning expectations

There’s no disputing the fact that the current risk management environment continues to challenge companies in a number of different ways. Rahul Badhwar, Global Head of Corporate Sales, Markets & Securities Services, HSBC, notes that the current risk management environment is generally challenging for corporates, given increased volatility across FX, rates, commodities and credit. “As the world emerges from the pandemic, with a focus on economic growth, companies have to monitor the markets for signs of slowdown and chances of recession,” he says.

“Inflation may be cooling in some markets but nevertheless continues to be of concern, whilst geopolitics has hindered global supply chains and led to reshoring in some cases, which can be an expensive proposition. Taken together, this has led to profit margin pressures for corporates, raising the stakes for their risk managers to mitigate those financial risks within a company’s control.”

These pressures represent a significant shift from historical norms, meaning that treasurers are having to adjust their expectations. “Who would have thought two years ago that euro-dollar would be at parity, which we are seeing right now?” says Thomas Jerolitsch, Vice President, Enterprise Treasury at FIS. “Who would have thought the Fed would hike rates to 1.75% in 2022? Who would have thought we would find ourselves at 8%+ inflation? Who would have thought tech stocks would plummet by 30% or more?”

As Jerolitsch notes, the combination of these developments is challenging corporate treasuries in many areas that they have not seen in recent history. “In a low-risk environment, whether you have money in a cash account or in some other forms of investment doesn’t make too much of a difference,” he says. “In a stable FX environment, whether you hedge 60% or 75% of your foreign currency cash flows doesn’t make too much of a difference.”

As such, the workload for corporate treasuries has dramatically increased as companies scramble to achieve the level of P&L and balance sheet predictability they have been used to.

Getting to grips with risk

Wolters Kluwer is a global provider of professional information, software solutions and services for sectors including healthcare, tax and accounting, and legal and regulation. The company is headquartered in Alphen aan den Rijn in the Netherlands, and reported annual revenues of €4.8bn in 2021. Wolters Kluwer manages business risks, which include changes in customer demand for products and the rapidly changing technological environment, alongside financial risks, such as currency movements, interest rate fluctuations, liquidity, insurance and credit risks.

“Identification and management of financial risks are carried out by the central treasury department, whereby the treasury operations are conducted within a framework of policies and guidelines (Treasury Policy), which have been approved by the Executive Board and the Supervisory Board,” says George Dessing, EVP, Treasury & Risk. “The Treasury Policy is reviewed at least annually, considering market circumstances and market volatility, and is based on assumptions concerning future events, subject to uncertainties and risks that are outside of the group’s control.”

A further risk that treasurers need to consider is fraud prevention, comments Dessing. “Criminals are taking advantage of disturbances caused by the ongoing worldwide pandemic, and recent events such as the invasion of Ukraine,” he says. “Their fraud schemes are becoming increasingly sophisticated.” As such, he argues that finance employees should remain “extra vigilant” regarding communications about financial transactions that they receive via app, text, instant message, phone or email – and treasurers need to make sure that the entire organisation is on an alert.

Hedging trends

Rahul Badhwar, Global Head of Corporate Sales, Markets & Securities Services, HSBC, says the bank is observing the following trends in light of the current economic outlook:

  • An increased use of optionality by corporates to protect budget and profitability targets.
  • An increase in hedge duration for USD net sellers as companies take advantage of historic spot levels in markets.
  • Hedging short-term emerging market risk, especially where local rates have lagged USD rates, thereby reducing their cost of hedging.
  • Significant uptick in interest rate hedging linked to current and planned financing/refinancing activities both in swaps and interest rate options.
  • Demand for yield enhancement structures from companies with sufficient cash buffers, to manage returns on excess liquidity which otherwise would lie idle.
  • Leasing and buying of precious metals to meet current demand.
  • Alignment of ESG financing with an ESG-linked risk management framework.

Navigating the challenges

In today’s environment, it’s difficult for treasurers to have a firm view of the market, “as a lot of factors impacting markets currently are outside of typical macroeconomic models,” says Badhwar. He notes that CFOs and treasurers are having to grapple with managing high inflation costs and the impact on operating margins, and that many “will not be able to pass on the full price pressure felt from their input factors into higher consumer prices.”

At the same time, Badhwar says that market volatility, and the speed with which some market moves have happened, is making it difficult for treasurers to make medium- and long-term decisions. Likewise, planning for hedge notionals is made more difficult by the uncertainty of the underlying exposures. Additionally, says Badhwar, “treasurers must manage interest rate risks when it comes to funding, as benchmark rates have been rising globally as central banks tighten policy to counter inflationary pressures in their economies.”

In light of these challenges, Badhwar says companies are currently reviewing their market exposures and risk capacity. “While some will not change their respective strategies (they are not going to react every time there is undue volatility), others are adjusting their hedging programmes across hedging instruments, hedge ratios, hedge duration and so forth, while those who have not previously had a hedging policy are now looking to implement one,” he says.

In particular, Badhwar comments that risks such as translation risk for overseas business investments (especially for US companies looking to protect dividend streams), interest rate risk from funding and FX risk on future expected cash flows (beyond the current accounting year) “are more relevant now than before for many companies.”

Adding value and harnessing opportunities

But while today’s environment is undeniably challenging, risk can also bring opportunity. As Badhwar explains, the inversion of US and other global yield curves is enabling companies to extend the duration of their interest rate hedges at cheaper levels, relative to current short-term interest rates.

“Given the outperformance of USD and stronger US rate hikes, the impact on FX hedging programmes will differ across geographies and sectors,” he adds. “Broadly speaking, for USD net sellers (eg exporters to US, and European/Asian groups with substantial net assets in the US), current hedge rates might appear favourable based on a relative value basis and longer historical perspective.”

On another note, with corporate valuations trending lower, he says some companies might look for opportunities to grow their operations via M&A. “In those instances, treasurers should increasingly be asked to safeguard the underlying transaction financials via rates and purchase price hedging (including deal-contingent solutions).”

Dessing, likewise, points out that not all of these developments are negative from a treasurer’s point of view. “In the wake of inflation, more volatility by recession risk, energy supply imbalance, geopolitical tensions, and the rising rate environment, treasurers need to conclude that money is not for free anymore,” says Dessing. “To me, this market shift is not a bad thing, as negative rates were pressuring economic sound practices, like the time value of money which was conflicting with daily routines for an effective and efficient cash management structure.”

With rising rates, says Dessing, treasurers need to take advantage of all opportunities to generate income and lower the cost of doing business. “This does require good forecasting, as it will allow you to optimise your investments in deposits or money markets, for example.”

On another note, he says it will be interesting to see how the company’s recent hires – “especially our talented youngsters” – cope with today’s more volatile economic environment. “It makes the treasurer’s job challenging, but also more interesting, and gives opportunity to provide added-value to the company,” he concludes. “In a period of volatility and economic uncertainty, it is even more important to incorporate a number of nationalities and cultures, while also including a rich mix of different education, experience and seniority levels within our treasury teams.”

Technology and data

What role can technology play in helping treasurers manage risks effectively in today’s environment? Thomas Jerolitsch, Vice President, Enterprise Treasury at FIS, argues that hedging strategies “are first and foremost a data challenge, meaning can I obtain adequate data on which to base my decisions?” In the past, companies may have been able to manage using estimates rather than actual data, but in today’s environment Jerolitsch says this is no longer feasible.

“As you look at your future cash flows, you may want to factor in some macroeconomic scenarios,” he explains. “What if you’re a large industrial company and your top customer reduces their order book? How does that impact your cash flows? And how much of that cash flow should you be hedging?”

Gaining access to the right data is one thing, but Jerolitsch also says companies need to be able to analyse their data effectively in order to make the right decisions about which hedging instruments to use. “From our perspective, there’s no way treasuries can get to the right data without having technology to help them mine, prepare and organise the data,” he says. “You also need to have the right people and the right capabilities, whether in-house or externally, to make the right decisions based on the data available.”

Today, says Jerolitsch, treasuries are looking to make better use of the data within the company’s ERP system, as well as other external data that may be relevant to their risk management and hedging strategies. Rather than having access to a ‘solution island’, he says treasurers are increasingly looking for integrated systems that enable them to capitalise on data within their organisations.

Gaining access to data is the first step. The second step is to interpret the data, which emerging technologies like artificial intelligence (AI) can help with. “If you look at forecasting, AI can help you overlay it with macroeconomic variables,” says Jerolitsch. “For example, you might have a projection of US$100m in 2023 – but based on AI you could say there’s a possibility this US$100m may only be US$80m next year. So I really see this advanced technology as a way to increase the value organisations can get out of their data.”

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