Cash & Liquidity ManagementCash ManagementCash Management RegionalA Treasurer’s Role in Managing FX Risk

A Treasurer’s Role in Managing FX Risk

There is also a renewed focus on foreign currency risk management, which in turn is driving corporate treasurers to adopt those electronic trading tools to manage their company’s bottom lines. Since execution processes are now more heavily scrutinised, there is evidence of a general trend to move trading off phones – where it is harder to measure execution quality – to electronic channels. Trading is fragmenting, while regulatory oversight and investor scrutiny is increasing.

For corporate treasurers, this has meant increased pressure to optimise working capital and ensure efficient cash management. While corporates once traded foreign exchange (FX) primarily for their hedging strategies, increasingly they are focusing on execution performance and execution risk. For instance, in the quest for more thoughtful trade execution and risk management, Thomson Reuters finds its multibank platform is used by corporates to manage multiple bank relationships through a single point of access to get the best price.

The number of payables and receivables that corporate treasurers need to manage on a daily basis means they will always need to hedge currency risk. However, the uncertainty in today’s markets is leading them to revamp those hedging strategies they use when trading on multibank platforms. As a result, many of them are beginning to adopt the use of FX options as alternative or additional ways to hedge exposures.

Options provide flexibility when hedging FX risk as they represent a right – but not an obligation – to take delivery of the currency. Starting with put and call options, corporate treasurers are tailoring complex instruments to meet their execution requirements. Following the move of FX spot, forwards, swaps and non-deliverable forwards (NDFs) to electronic trading, banks have gradually developed electronic option platforms and many leading FX banks are able to offer their clients functionality to electronically price, trade and risk-manage a variety of option strategies.

On today’s platforms, customers are sending out option request for quotes (RFQs) to multiple provider banks simultaneously and dealing electronically on the best price. New electronic platforms with automated option pricing allow corporate treasurers to receive competitive option prices electronically regardless of the notional size, maturity, or strategy. In addition to settlement and reporting capabilities, these multibank option platforms offer treasurers the benefit of straight-through processing (STP) into their treasury management systems (TMS), with the most useful offering a complete end-to-end workflow solution.

The time savings benefits from trading FX options electronically are significantly greater than those for other FX products, such as spot and forward, because of the unique workflow for options due to premium payments and option expiry execution decisions. In addition, since the options market is not as liquid, getting prices back from banks can take longer and electronic solutions can speed up execution time and minimise risk. The early adopters of multibank options trading platforms are reaping both the time saving and efficiency benefits with a solution that can be trusted to comply with future regulatory requirements.

Meeting the regulatory obligations

The key regulatory drivers stem from both the US Dodd-Frank Act and the EU European Markets Infrastructure Regulation (EMIR). For example, under both regulations, market participants are required to report trades to a data repository. Often times, the data elements required for a complete trade submission are not contained in one system – an operational headache. Under EMIR, market participants are expected to verify a great deal of information with trade counterparties (for example, unique trade identifiers (UTIs), trade submissions to repositories, confirmation processes and dispute resolution procedures), while the mechanisms to perform such verifications are nascent or non-existent.

Phase One of the EMIR trade reporting obligation went live on 12 February this year and phase two, reporting of collateral and valuations, will go live on 12 August. To help clients prepare for these deadlines, Thomson Reuters provides an FXall transaction data report and a trade reporting service into the Depository Trust and Clearing Corporation (DTCC).

To help clients meet regulatory requirements for trading FX derivatives under Dodd-Frank, the group launched the Thomson Reuters Swap Execution Facility (SEF), which enables customers to trade FX non-deliverable forwards (NDFs) and FX options electronically through multibank request-for-stream (RFS) liquidity and an anonymous order book.

The group actively reviews all of the relevant consultations from regulators across the globe, and often provides detailed, technical responses. Regulators are keen to understand all of the likely consequences of their proposals, and rely on detailed submission by firms on behalf of their clients to ensure regulation is appropriate, proportionate and fair.

Best Execution Analysis

In their quest to maximise performance and achieve best execution, an increasing number of corporate treasury departments are also deploying execution quality analysis tools as part of their workflow. Electronic trading platforms can record the price, time and market references for trade executions; advanced execution quality analysis tools enable analysis of FX investment decisions and execution strategies. Companies are better informed and are able to manage in greater detail their best execution goals.

Most actively traded currency pairs, spreads by time of day, response times by trade size and currency and counterparty performance are all useful indicators to corporate treasurers seeking to improve their FX execution performance. Opportunities to net trades can become apparent, offering increased process efficiency and cost savings. Trading activity can be compared against the market high and low for the day.

As more treasury departments have begun to integrate these types of reporting, analytics and tools with the benefits of an electronic FX trading platform, the improvements to execution performance have been significant, allowing corporate treasurers to capitalise on new opportunities in the fast-changing FX market place. 

Actively Managing Risk

More recently, corporate treasurers have begun to assume more risk in their FX trading as another way to reduce costs. This new active trading approach leverages trading tools, such as advanced order types and bank algorithms, which access electronic communication network (ECN) liquidity anonymously. Most corporate treasurers are accustomed to relationship-based trading where they trade on a disclosed basis with their bank counterparties. ECNs work differently – since no counterparties are disclosed, all trading is facilitated through prime brokerage relationships.

Some corporate treasurers who are comfortable with managing their risk actively have accessed advanced order types and ECN liquidity themselves directly. Others interested in the benefits of active trading, and who prefer to trade with a consistent workflow on the traditional disclosed basis, are using electronic platforms to route customised algorithmic orders and send resting order requests directly to their banks for them to manage. Banks offer a wide range of execution algorithms that utilise active trading strategies and access diverse liquidity pools. Corporate treasurers have the flexibility to choose exactly which approach will work for specific market conditions. For example, they can customise the orders they send to banks based upon their risk tolerance, execution style and trading objectives.

However, before moving to the anonymous ‘all-to-all’ nature of an ECN or order book, corporate treasurers should think about how much risk they want to assume in their FX trading and what they want to achieve from any additional execution alternatives – from faster execution of trades, to minimising market impact, to matching third party benchmarks or lowering transaction costs. It is therefore important that traders carefully evaluate which execution mechanism is appropriate for a particular objective in order to maximise performance and that they continually re-evaluate their choice of trading mechanism – based upon their actual results – to ensure that their objectives are being met. Additionally, both investors and regulators will increasingly expect corporates to demonstrate that they have considered, and can justify, why a certain execution method was chosen for the trading strategy.

This more active type of trading has not replaced the need for corporate treasurers to nurture bank relationships, nor does it eliminate their need for relationship-based trading. For corporations, good banking relationships will always be crucial to fulfilling certain trading objectives such as getting tighter, faster pricing in full amounts. However, this trend highlights how corporate treasurers can thoughtfully approach their FX trading more strategically by evaluating execution alternatives, how to get to the market faster, build a position or manage risk differently.

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