It is vital that corporate treasurers have effective risk management strategies in place to mitigate the impact of currency exposures, but to do so, treasury teams must first gain a deeper understanding of current trends in the FX market, according to Eric Huttman, CEO of MillTechFX
According to recent research from Kyriba, although the collective negative impact of foreign exchange exposures was down in Q3 of 2021 compared to the previous quarter, FX volatility is trending upwards again and is expected to continue for the remainder of the year.
Against a backdrop of “supply chain disruption, currency volatility and inflation”, CFOs will be “expected to demonstrate strong balance sheet and cash forecasting precision with various cash flow scenarios,” according to the research report.
Navigating FX risk, however, has been challenging for finance professionals for a variety of reasons. PwC’s recent Global Treasury Survey 2021 found that inaccurate forecasting and poor visibility were the biggest challenges facing treasury teams. This made the task of FX risk management like hitting a moving target.
These issues had a direct impact on many businesses profitability with HSBC’s latest corporate risk management survey finding that 57 percent of CFOs (rising to 77 percent in EMEA) saying they suffered lower earnings in the past two years due to significant unhedged FX exposure.
Managing risk is evidently a pain point for corporate treasurers in the search for best execution. With economic changes, such as further interest rate rises on the horizon, CFOs and treasurers need to prioritise optimising their FX risk management to deliver sustainable growth and protect their company’s bottom line.
Lessons learned from asset managers and institutional investors mean that corporates are increasingly looking to third-party Transaction Cost Analysis (TCA) to quantify their FX costs and demonstrate strong governance to internal stakeholders and shareholders alike.
TCA was specifically created to highlight hidden costs and enables firms to understand how much they are being charged for the execution of their FX transactions. It goes hand in hand with best execution, serving as an ongoing audit of FX practices.
By focusing on the ‘G’ of ESG (Governance) we can begin to make substantial progress towards our sustainability goals. Having strong governance around best execution practices, supported by regular, independent TCAs, could pave the way for introducing more sustainable risk management practices in FX.
As businesses start to rebuild in the wake of the COVID-19 pandemic, the treasury role could expand and come under even more pressure. To make their function more scalable and to cope with this demand, many are likely to turn to outsourcing.
This move is already underway as evidenced by research from HSBC and Acuris which found that 44 percent of CFOs in larger companies have outsourced some of their day-to-day functions.
In our view, cloud-based tools are being increasingly utilised to digitise and automate the entire FX process as a method to improve efficiency and cut costs. By embracing a digital FX marketplace, firms can get heightened visibility and subsequently reduce risk.
Liquidity and funding requirements are one of the biggest challenges faced by corporate treasurers today, particularly in the ‘new economic environment’ outlined in the Kyriba report. Businesses should explore ways to eliminate unforeseen demands on free cash flow, and one such demand might arise from financial risk management.
For example, corporates may have to post collateral against FX hedges in the form of initial or variation margin. After posting cash collateral with an FX counterparty this capital is essentially dormant; it isn’t earning a return for the company and may not be able to be accessed at times when they might need it most.
CFOs should explore hedging solutions that are margin free and don’t pose a threat to free cashflow.
Future proofing treasury’s FX function
The post-pandemic market is set to bring new challenges for corporate treasurers. Macro-economic factors such as rising inflation, rate hikes and geopolitical tension have left many CFOs seemingly paralysed by external uncertainty, making the task of navigating FX risk extremely challenging.
Firms need to focus on their risk management infrastructure to fully adapt to this changing financial climate. Many are moving towards centralised, digital solutions which offer more effective FX risk management processes. These solutions can also help ‘future proof’ a treasury teams’ FX function, with the added benefits of driving operational efficiency and reducing risk through automation and outsourcing.
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