Corporate TreasuryFinancial Supply ChainSupply Chain FinanceReport: Volatility plagues treasurers in search of the right hedge

Report: Volatility plagues treasurers in search of the right hedge

2021 set to be a tough year for treasurers as uncertainty over pandemic continues

The shock and disruption caused by the pandemic has seen volatility remain high, worrying corporate treasurers as they look to manage their hedging strategies in 2021.

Since the pandemic hit markets in March, volatility indices like the Chicago Board Options Exchange’s CBOE Volatility Index (VIX) has stayed over 82 percent higher than the pre-pandemic year low, according to data from CBOE.

“We need to recognise that volatility in financial markets is not going away,” says Thomas Jerolitsch, general manager enterprise treasury at FIS. “This obviously means that for corporates, being able to hedge that volatility will be an absolutely key factor for them.”

Fred Schacknies, treasurer-elect at TechnipFMC is also concerned about the uncertainty over the coming year and predicts a challenging time as corporates are forced to wait and see how the various coronavirus vaccines are rolled out in different countries.

“I think the key challenge for many corporate hedgers is now uncertainty in the business, even more so than uncertainty in markets. I’m sure many firms have had to unwind hedges as underlying revenue and profit disappeared due to the pandemic. They may be reluctant to add them back, even as business slowly resumes. Likewise, firms facing exponential growth may be challenged to confidently project future exposure.

“Whether firms are facing disrupted business models or unprecedented growth, there’s increased risk of over- or under-hedging. For that reason, I would expect 2021 to be a very difficult year for hedgers,” Schacknies added.

Schacknies says treasurers need to move beyond simple hedging strategies to successfully navigate the uncertainty and volatility in the market.

“I think coronavirus has shown that corporate hedgers will need to think of underlying risk in a more multi-faceted way, with contingencies and compound effects. A simple factor sensitivity or a bell curve on market prices probably isn’t a good enough representation of outcomes.

However, Christof Nelischer, former global group treasurer at Willis Towers Watson says being too cautious could come back to haunt treasurers with volatility still high. While corporates have generally taken this approach in challenging times, this may not be appropriate on this occasion.

“In the current environment it is increasingly difficult to predict what that [the future] will be like, and in a volatile market it may turn out to be the wrong course of action to hedge too early,” he said in an email.

There has been a further strain on corporates as margins are becoming thinner, says Dave Pierce, managing director, global hedging products at GPS Capital Markets. Pierce says that has meant the importance of hedging can no longer be easily ignored.

“We’ve seen people that have not hedged in the past realise that they’ve got to get into the hedging game,” says Pierce. “The tariffs that have been put on in the US have really hurt margins. The shipping costs have gone up dramatically… in some cases they have tripled.”

“I work with a big company that has quite a low margin, a seven or eight percent margin. They got hit with the tariffs from China of 25 percent. So, if you’ve got an eight percent margin and all of a sudden, you’re paying a 25 percent tariff, guess what? That doesn’t work – you’re losing money on everything.

“When your margins get down to four or five percent, you can’t afford to let anything else happen because otherwise it’s not worth it to do business,” Pierce adds.

Impact of ‘crazy’ stock market

While the pandemic has led to increased uncertainty, supply chain disruption, thinner margins and a severe economic impact on global GDP, the stock markets have continued to rise at pace.

The Dow Jones Industrial Average dropped below 20,000 in March 2020, but has risen steadily to exceed the pre-pandemic high and break through the 30,000 barrier for the first time in December 2020.

Pierce thinks stock markets don’t currently reflect “true values”, making the start of 2021 a risky moment amid fears of a potential market crash. On January 5, the co-founder of GMO, Jeremy Grantham wrote about his fears that the current market is a “bubble beginning to look like a real humdinger”.

The cost corporates will have to bear won’t be drastically altered by the success of vaccine programmes either, says Jerolitsch, with tax increases expected.

“We have already incurred the cost of coronavirus. Governments will need to fund that cost.

“Vaccines will certainly have benefits on a much wider scale, but it does not change the underlying, very fundamental economic model,” he adds.

Tech infrastructure crucial

The growing scepticism in the stock markets, coupled with the wider economic difficulties that will force governments to use what levers they have to pay for the pandemic in 2021, means that treasurers will have to face up to yet more uncertainty and risk.

Andrew Hollins, director of corporate treasury proposition at Refinitiv says the increasingly common levels of high volatility mean treasurers will have to invest in suitable technology as part of their hedging strategy.

“We’ve had so-called black swan events come along… we’ve had how many in the last 10 years? So, are they black swan events anymore,” Hollins asks.

“In practice, what we’re seeing is more extreme events have happened more frequently. There’s a feeling from certain corporates who say we do need some kind of framework and platform that, in an automated way, is able to run these analyses because this is our most important function as a corporate treasurer – to ensure the solvency of the business.”

Laurent Descout, CEO and founder of NEO says too many corporates simply don’t have a hedging strategy when they need one, particularly in the current climate.

“With political uncertainties, super-high volatility of foreign exchange rates and globalisation, whether you’re an SME or midsize corporation or a multinational there is just no procurement cycle that does not involve a returns component. So, it’s critical to have a hedging strategy and yet we find a lot of corporates who do not have one.”

Schacknies says that while there are basic technology solutions for hedging needs, many firms haven’t implemented them yet. What’s more, treasurers are now more aware of the complexity of their risk profiles. However, treasurers still don’t have solutions available to answer the most important questions they’re asked by the C-suite, he says.

“What doesn’t exist are solutions that help answer the questions treasurers are asked by CFOs, CEOs and boards: ‘what impact does FX/IR have on our outlook for revenue/Ebitda/EPS?’

“But, therein lies one key trait of a successful treasury executive: making the complex simple to understand,” Schacknies adds.

For Hollins, it comes back to the notion of predictability being key. As the treasurer’s remit gets larger, whether that be due to regulatory encroachment or ESG or supply chain risk, a treasurer can’t continue to do their role successfully without data and automated workflows, he says.

“[Treasurers] want to make sure going forward, that they have visibility and transparency on cash forecasting and cash positions. They want to have an idea of predictability,” he says.

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