The Rise of Corporate Currency Exposure Management
The way that corporations manage their currency exposure has taken a dramatic leap forward over the past six years. Treasury departments have evolved from disparate desks using proprietary reporting systems and dealing predominantly over the phone, to trading huge volumes online using cutting edge control and compliance tools. Corporates have embraced FX and in doing so moved from having an outline view of their currency requirements to actively managing currency risk using advanced technology and processes. The main shift in focus has taken place as corporates leverage technology to move towards a new, centralised treasury model that streamlines trading between the head office and regional treasuries/subsidiaries.
A key influence in the evolution of treasury services within today’s corporates, and in particular in the shift towards electronic trading, has been regulation. The introduction of the Markets in Financial Instruments Directive (MiFID), for example, encourages both best execution and best practice. Best execution was previously achieved via prices taken over the phone from brokers, which is no longer a robust or practical practice given the huge volumes corporates now trade. Trading via online platforms, however, provides the complete audit, control and compliance functionality, and tools to facilitate best execution requirements.
Regulation that encourages enhanced auditability and internal controls, such as Sarbanes-Oxley, IAS30 and FAS133, have all increased the need for strong underlying accounting tools. This in turn has increased the demand for SAS-70 certified vendors, which have been independently audited and certified and are able to demonstrate adequate controls and safeguards in the hosting or processing of data belonging to their customers. SAS-70 certification is, therefore, a key attribute sought by many financial services and corporate institutions in their partners.
The centralised model has been fundamental in enabling corporates to actively manage FX for the benefit of the corporation, and in doing so removes many of the problems they previously faced. The model is a simple one – a centralised treasury desk that manages regional treasuries and holds responsibility for all currency exposures, netting, compliance, trading and liquidity distribution across the enterprise – but the benefits are wide and varied.
Importantly, the centralised model gives regional treasury managers increased flexibility in managing the business and its interests locally, without putting the wider company at risk by taking positions that aren’t being hedged centrally. This flexibility is key in allowing the local business to be responsive to their individual needs whilst the central treasury holds the responsibility for overall risk management.
This structure is important in a number of ways. Firstly, each business unit is able to follow their defined methodology and strategy while contributing to changing market conditions. Regional treasurers are best placed to manage risks on the ground and can respond promptly to any developments or local market insight. Secondly, all exposures are consolidated into one complete viewpoint, with all positions managed, netted and hedged by the central treasurer who holds an overall view of the liabilities across the entire organisation.
Centralised treasury departments can act in one or both of two ways:
Treasuries, therefore, not only manage how they go to market and receive a better price by acting as a single corporate unit, but can use advanced technologies to actively net off trades on a cross currency basis. This reduces the reciprocal amounts due on a set of foreign exchange contracts, therefore reducing the size of cross-currency settlement exposures. The reduced bid/offer price on both sides of the trade not only reduces trading costs, but benefits the business by reducing the overall cost of funding.
Reduced trading and funding costs are not the only advantages of a central treasury function. By establishing a single accounting system and one centre for settlement, processing and full back office automation, corporates increase straight-through processing (STP) rates and reduce manual processing. This holistic view provides a more accurate representation of currency liabilities, allowing treasuries to actively manage exposure and limit lines and spread of credit, for example.
Allowing local treasurers the freedom to operate as individuals whilst providing the tools and processes to hedge centrally is key to the success of the centralised model. Relationships play an important role in the FX market, particularly at times of heightened volatility and market unease as participants see the value, and take advantage, of the relationships, credit lines and liquidity that are available. Local treasurers are able to leverage their expertise and relationships for maximum effect in this respect. While demand for anonymity is steadfast as corporates look to manage and offset risk by using multiple venues, the ability to place business based on relationship as well as price is a valuable way of trading in the market.
The local treasurer will also have greater insight into, and understanding of, the relevant currency pairs and the strategy that should be employed in order to hedge their risk. For example, corporate activity in the non-deliverable forward (NDF) market has risen greatly, and this is partly as a result of flows from local treasurers.
The increasing use of NDFs by corporates involved in emerging markets – and the growing sophistication of NDF use – is not just derived from European or US institutions looking to hedge their exposure to Asian, Latin American or Eastern European currencies. As Asian corporations increase their exports, they too have become increasingly involved in dollar-Asian markets over recent years as they look to hedge dollar risk against their own currencies.
The uptake of electronic trading and the tools that facilitate compliance has brought transparency to the FX market, which in turn has allowed corporates to actively participate in a greater number of product sets, including NDFs. NDFs have historically been more difficult to automate than instruments such as spot or forward outrights. This is both because they are a more complex instrument – the requirement to specify a fixing mechanism and fixing date introduces an additional layer of complication – and because, until recently, they have not been standardised. In the NDF market, companies want to see a multi-bank offering that meets their hedging needs.
Corporate involvement in the FX market has, therefore, not only expanded and become significantly more sophisticated, but there is increasing scope for further innovation. Centralised treasuries are more co-ordinated and profitable as a result of actively managing their positions and the currency requirements of regional treasuries and subsidiaries. This is very much the future for corporates who are increasingly moving towards white-labelling services that allow the centralised treasury to actively manage FX trading in this way. White-labelled solutions provide corporate treasurers with access to complete bank functionality for internal dealing, including automated price-making capabilities. This allows the central corporate treasury to make automated prices on demand to internal clients, who in turn are able to execute immediately with the central treasury desk.
In the past, the centralised treasury model was an expensive option as corporates struggled to manage ticket volumes and maintain pace with demand. Now, however, sophisticated tools are available that make it not only easier but a solution that adds value to the bottom line of an organisation. Corporates are, therefore, fixed on a strong course of evolution and no longer view FX as the problem child it once was. With the right tools and processes, internal dealing is now faster and more efficient. As the requirements of corporates continue to diversify, the ability to hedge centrally and take advantage of value-add services, such as netting, are now more important than ever in a sophisticated – and increasingly regulated – global landscape.
Utilising local knowledge to navigate markets and providing regional treasuries with the freedom to make the decisions that best impact their business is vital for any global organisation. Now more than ever, having a global risk management view and the ability to manage and hedge positions centrally using intelligent tools and workflow offers corporate treasurers the benefits of both worlds as they navigate increasingly volatile markets and constantly shifting liquidity.