What's Your Future FX Risk?
Today, most multinational corporations struggle with foreign exchange exposure management processes that are cumbersome, manually-driven and error-prone. Despite adopting all kinds of sophisticated software tools, such as ERP systems, multi-currency general ledger systems and advanced consolidation and reporting tools, the majority of multinational companies still struggle with this key question: what is the foreign exchange exposure to our balance sheet and cash flow forecasts and how can we protect our margins, our revenues and the value of our firm from unanticipated foreign exchange volatility?
Somehow, the answer falls through the cracks when it comes to the software solutions that exist in most treasury organisations today. Banks rely on sophisticated instruments to automate the trade execution process, while treasury and accounting systems have streamlined the process of confirming, settling and accounting for hedging transactions after the fact. Currently, however, treasury departments neglect the critical pre-trade activities and decisions that drive their entire foreign exchange transaction lifecycle, relying on manual processes and the expertise of a few individuals within their organisation to sort it all out.
Corporate foreign exchange managers today typically rely on error-prone manual data entry practices and complex spreadsheets that produce incomplete and unreliable foreign exchange exposure data. Ad-hoc data entry errors, combined with institutionalised formula errors account for the fact that over 90% of spreadsheet models have major flaws that affect the bottom line by more than 5%. As a result, foreign exchange exposure management continues to involve more art than science, yielding imprecise and inaccurate results. By accepting this state of affairs, companies have put themselves at considerable financial and compliance risk, making them vulnerable to factors beyond their control – from internal events such as employee turn-over to external, unforeseen currency volatility.
Of course, it doesn’t have to be that way. Multinational corporations now have tools at their disposal to automate and streamline their data gathering efforts. They can implement straight-through data processing from accounting systems to data and exposure management tools, thus eliminating data entry errors. These new exposure management tools can ensure data integrity by providing visibility into the underlying foreign exchange data, while helping to illuminate the root causes of exposures. By institutionalising the business rules that guide their decisions, they can even automate the decision-making process, taking advantage of data- and policy-driven recommendations to eliminate exposure and reduce risk.
Taking the next step, multinational corporations can look beyond point-in-time foreign exchange exposures to examine foreign exchange volatility impacts on forecasted cash flows over time. Here again, the tools now exist to automate these processes, making it easier to aggregate the right data, analyse it over time and implement decisions to protect revenues and margins.
In both cases, institutionalising the foreign exchange exposure management process protects the company from internal changes by embedding knowledge within the system. Here’s a high-level look at how you can make foreign exchange exposure management a forward-looking part of your economic strategy, rather than an unanticipated consequence of uncoordinated activities.
For most FX managers, simply getting their hands around their FX exposure data represents 80% of their related workload. Automating this process reduces errors and saves time that can be better spent analysing the data to uncover the root causes of exposure and making timely, strategic decisions.
Today, software-driven foreign exchange exposure management systems automate the process of gathering data by supporting either straight-through processing from existing systems, or the upload of data from spreadsheets. The significant time saving benefits of streamlining this data entry are obvious, but its the elimination of a whole set of manual data entry errors that ultimately has the greatest impact.
Of course, any FX manager will tell you that manual data entry errors are just the tip of the iceberg. By applying exception-based analytics to the uploaded data, foreign exchange exposure management systems can identify the most common and difficult to detect institutionalised errors. Problems such as missing exposure data, unexpected changes in exposures, erroneous transactions and incorrect postings to the general ledger are identified immediately, without the kind of tedious and time-consuming manual review it would otherwise require.
Here is where data management automation really proves its worth. In the hundreds of FX spreadsheets analysed by my firm, nearly 80% had missing entities. Over 60% had missing accounts. In our experience, the next most common source of spreadsheet errors was data transposition. Formula transpositions turned up in over 25% of the cases, and data transposition in nearly 15%.
When presented with accurate, reliable data, the next thing the FX manager needs to manage foreign exchange exposure is a way to get a comprehensive view of the data and drill down into the details. While this is critical for managing foreign exchange exposures to balance sheets, it is essential for managing forecasted exposures to cash flows.
Managing foreign exchange exposure to balance sheets, where FX managers can rely on data available within the treasury and finance organisation and focus on a fixed point in time, presents a daunting enough task. Now, factor in the challenge of trying to gather relevant forecasted cash flow data across the organisation and aggregating it into relevant account groups to effectively manage exposures for each entity. If that wasn’t enough, now manage those exposures based on your confidence in your company’s own unique take on forecasting cash flows over time. Without a sophisticated data and exposure management tool to automate and institutionalise this process, the best result that any FX manager can achieve is closer to fortune telling than forecasting foreign exchange exposure to cash flows.
To handle the unique data requirements for forecasted cash flows, today’s foreign exchange exposure management systems rely on template-driven interfaces that help to identify the required data and provide a framework for ongoing data collection and validation. More importantly, these systems allow FX managers to organise relevant financial data into account groups so they can manage them based on accounting or economic criteria to reflect their organisation’s FX policy objectives. Once this data is properly organised, FX managers can then define their hedge strategy and apply decisions to these groups accordingly.
When the time factor is added into this equation, FX managers will want some way to address their degree of confidence in forecasts and their associated hedges based on how far out their company has made its projections. The leading exposure management systems available today allow FX managers to apply a ‘hedge factor’ to exposures in the form of a series of percentages over various time intervals, without altering their original forecasted balances.
Combined with rules-based decision-making tools that provide FX exposure management recommendations and allow FX managers to try out ‘what-if’ scenarios in real time, foreign exchange exposure management systems help to instantly illustrate the impact of an FX manager’s strategy for eliminating exposures and mitigating risk.
The benefits of switching to an automated process are clear, and the impact can be deeply felt throughout an organisation. Based on research conducted by PWC, companies that automate risk management processes are 50% more likely to benefit from accurate, timely, consistent, and complete risk information. Not surprisingly, executives and boards of firms that automate risk management processes make faster and better risk management decisions, resulting in improved earnings and margins, and increased competitive advantage.
These benefits manifest themselves in numerous ways. Some can be easily quantified, including the volume and cost of transactions. Greater visibility into a company’s foreign exchange exposure makes it easy to eliminate erroneous transactions and their associated costs. More timely and efficient decision-making allows FX managers to execute transactions for the time of day and time of month that affords them the best rate of exchange, rather than rushing to make costly last-minute, end-of-the-month transactions.
There are plenty of intangible benefits, too. Many of these have significant value to a corporation, particularly when it comes to compliance with FAS 52/IAS 21, FAS 133/IAS 39 and Sarbanes-Oxley. Automated systems help companies to properly account for the impact of currency revaluation and re-measurement on its financial statements in support of FAS 52/IAS 21, while providing relevant data to hedge accounting systems to support FAS 133/IAS 39 documentation. At the same time, automated systems give companies the confidence they need to attest to the accuracy of their foreign exchange processes and the supporting data required for Sarbanes-Oxley 404 and 302 certification.
Ultimately, any company that is serious about eliminating foreign exchange volatility as a source of uncertainty from their balance sheet and cash flow forecasts, and wants to inspire confidence among senior managers, the board of directors and investors in their margins and revenues must understand and effectively manage their foreign exchange exposure. Eliminating the art and mystery from FX exposure management practices and replacing them with institutionalised best practices and automated processes is clearly the way forward.