Cash & Liquidity ManagementCash ManagementCash Management RegionalForeign exchange: Managing uncertainty in 2016

Foreign exchange: Managing uncertainty in 2016

Hopes that 2015 would prove a calmer year in the currency markets were swiftly dashed as the euro fell sharply against the US dollar, China moved to weaken the renminbi and many emerging market currencies fell sharply in response. Not for the first time, fears that a ‘currency war’ could break out were prevalent. How are companies coping in this volatile environment and what policies do they favour in mitigating the effects of sharply appreciating and depreciating currencies?

The start of 2016 has already seen a considerable amount of volatility in the currency markets. As we closed out 2015 we saw spikes in volatility following the European Central Bank’s (ECB) continuation with quantitative easing (QE), and the Federal Reserve’s decision to tighten its policy with the first US interest rate increase in over nine years.

As we carry over from last year, it is clear that currency movements are correlated globally and no longer regionalised. We can also reasonably predict that, unlike other eras of heightened volatility, what we are witnessing today is persistent volatility and will extend into the foreseeable future. As a result, sitting on the sidelines to “wait out the volatility” is not an option for chief financial officers (CFOs) and treasurers.

Effectiveness of hedging policies

Agility in managing policies to maintain the value of foreign denominated cash flows will be the focus of corporate treasuries in 2016. Historically, defining a hedging policy presumed that volatility was short-term, leading to certain choices in duration and derivative instruments to be used. Today, those assumptions are not necessarily valid, so it is necessary to review hedging policies to ensure they align with current market conditions and predictions. Policies should also be checked to ensure that they are reflective of the currencies that the organisation is exposed to, as today’s currency environment may be much more complex than when the hedging programme was initially designed.

Visibility and forecasting

CFOs and treasurers often lack visibility into cash positions and forecasts. A study by Protiviti, a subsidiary of recruitment firm Robert Half, identified that “cash forecasting represents one of the highest-ranked priorities in our study” of CFO’s top issues in 2016. Forecasting is a strategic issue because the inability to rely upon a 13 or 26- week forecast inhibits the ability to effectively hedge foreign denominated cash flows. Accuracy in forecasts is critical in properly planning and executing on the management of exposures in foreign, more risky regions of the globe.

Cash visibility is not just about accurately predicting future cash flows. Treasurers continue to seek out efficient connectivity solutions to reach 100% visibility, instead of the 80-90% visibility of cash key performance indicators (KPI) that used to be good enough when currencies were more predictable. Increasing visibility serves to increase the choices available to treasury teams to protect and/or mobilise foreign cash.

Cash pooling and in-house banks

In-house banking programmes are also growing in popularity as a means to more easily move funds and reduce exposures. Through an in-house bank (IHB), corporations are more easily able to gain visibility into the company’s net exposures by combining cash pool activity, intercompany invoices and structured lending agreements. Internal and natural hedges are more easily identified through the use of an IHB, leading corporations to more effectively manage the net exposures at an enterprise level as opposed to managing regionally. Treasurers are also able to reduce trapped cash in regions that may feature more volatile currencies, further reducing FX exposure. Additionally, through multi-currency pooling, corporations are potentially able to optimise their banking footprint, reduce banking fees and achieve more favourable FX rates, and thereby realise lower overall costs.

Nowhere in the world has cash pooling been more interesting than in China. Less than a month ago, Bank of America announced its new cross-border cash pool in China for support of companies operating in the Shanghai Free Trade Zone (SFTZ). Similar to other global banks’ initiatives, registered corporates have the opportunity to make Chinese subsidiaries part of their global cash pool through onshore/offshore sweep programmes. This not only allows repatriation of cash flows earned in China, it also more efficiently supports hedging of renminbi (RMB)-based exposures.

Global supply chains

With companies becoming more international, global supply chains continue to expand, putting pressure on CFOs to manage a greater number of suppliers as well as additional foreign currencies in these new regions. This also impacts on working capital, as payables may not fully align with receivable currencies – forcing treasurers to mobilise cash.

Global supply chain finance programmes help meet this need, with banks keen to introduce multi-currency funding. Supply chain finance programmes serve to improve working capital for “the buyer” by extending payables terms while simultaneously feeding suppliers’ need to improve their own liquidity positions. From an FX perspective, companies will more easily be able to make payments through these models and manage collections specifically in emerging markets, thus reducing the overall exchange rate risk in those areas. Bringing together multiple banks to support a supplier financing programme also allows partnering with banks that have regional specialisation, as well as increasing the overall financing of the programme.

In summary

There are many strategies to support gaining visibility into foreign currency exposures as well as taking steps to mitigate FX risk. Whether an IHB or a new supply chain finance policy, treasury teams can be more agile, enabling CFOs and treasurers to be more proactive in aligning their strategy to the persistent volatility in today’s currency markets.

Technology further empowers the CFO, by not only reducing FX risk but also eliminating operational risks such as those presented by manual workflows, reliance on spreadsheets, and potential disruptions due to disasters or unforeseen events. Having technology in place that can quickly and seamlessly integrate exposures and positions from financial institutions, trading partners and local accounting data from an enterprise resource planning (ERP) system is very important in an environment where IT teams are lean and unavailable to finance.

Treasury’s effectiveness in FX risk management is strategic to the organisation’s financial performance and ensuring that the CFO and treasurer can achieve independent business continuity will ensure the organisation is armed and ready to combat FX volatility.


More reading: What are the major foreign exchange risks?

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