Currency woes deepen for treasurers as FX volatility outlook darkens
Volatility across FX markets shows no signs of abating but there are sound strategies treasurers can employ to help mitigate currency impacts
Volatility across FX markets shows no signs of abating but there are sound strategies treasurers can employ to help mitigate currency impacts
FX challenges for treasurers are intensifying, with latest currency impact data from Kyriba showing North American and European corporates suffered a combined negative impact of $16.5bn in the first quarter, more than double the $6.7bn impact over the fourth quarter.
Kyriba’s Currency Impact Report (CIR) for the first quarter is based on analysis of earnings calls with 1,200 publicly traded North American and European multinationals that do business in more than one currency and have at least 15% of their revenue coming from overseas.
Both North American and European companies indicated that the Russian rouble, which has been strengthening against both the dollar and euro this year despite Russia being in an economic crisis, was the most impactful on their FX operations.
The rouble is being driven by export-focused companies being required by Russia’s government to convert their foreign currency revenue into roubles after sanctions froze nearly half of the country’s gold and forex reserves.
Andy Gage, SVP of FX solutions and advisory services at Kyriba, foresees major challenges ahead for treasurers on the currency front.
“Headwinds have increased dramatically since the fourth quarter of 2021 as the US dollar has gone on an unprecedented run against the euro and the other major currencies that US multinationals are exposed to,” he says.
“The combination of the strong dollar, persistent FX volatility and rising hedging costs means CFOs and treasurers need faster access to accurate FX risk data and more sophisticated analytics to help shield their financials from adverse currency impacts and excessive hedging costs.”
It is now more expensive to hedge against currency headwinds than earlier this year, according to Gage, with this posing a challenge for CFOs looking to minimize FX headwinds on their earnings and cash flow.
“We see CFOs who do have greater transparency into currency exposures in their financial statements implementing strategies to organically reduce net currency exposure, allowing them to hedge less to protect their balance sheets and future cash flow.”
Looking ahead, Gage anticipates continued strengthening of the US dollar, noting it recently reached parity with the euro for the first time in 20 years. This ongoing appreciation will lead to CEOs and CFOs in US multinationals to further restate guidance for the rest of 2022, he says.
“It is reasonable to expect additional impacts of 2% or more to revenue and earnings as organisations struggle to mitigate the impacts of market volatility in second quarter and beyond.”
For Eric Huttman, CEO of MilltechFX, an independent multi-bank FX marketplace, the Kyriba report underlines the pressure treasurers are under to ensure their FX strategies, management and controls are fit for purpose.
He believes it is likely currency volatility will remain a dominant theme over the next couple of years and that as a result, “management of FX currency risk must be a top priority for treasurers”.
There are several ways treasurers can improve their FX risk management infrastructure and protect their firms’ bottom lines in these turbulent times, according to Huttman. These include the use of Transaction Cost Analysis (TCA), a widely used technique for highlighting hidden costs and enabling firms to understand how much they are being charged for the execution of their FX transactions.
Rolling quarterly TCA studies by an independent TCA provider can be embedded into treasuries as a new operational practice to ensure consistent FX execution performance, he says, adding that comparing the market can also make a valuable contribution towards an efficient FX operation.
“Having the ability to put trades up for competition is central to ensuring access to best price, which is key to effective hedging,” he says. “However, many treasurers are hampered by their inability to access Tier 1 FX liquidity, meaning they often rely on a single bank or broker to meet their hedging requirements.
“A new generation of fintechs is tackling this problem, enabling treasurers to access rates from multiple banks whilst reducing the operational burden associated with this kind of market access.”
One of the most common approaches treasurers take for FX hedging is to use forward contracts. These are hedging products that allows them to secure an exchange rate over a set time period on a predetermined volume of currency, mitigating the impact of currency volatility.
However, corporates who hedge using forward contracts must consider that placing a hedge can require margin to be posted against that position as collateral, says Huttman. Furthermore, if the initial margin no longer covers the mark-to-market of a hedge, due to movements in the underlying FX rate, the corporate may be required to post additional, variation margin.
“Any capital posted as collateral is effectively sitting dormant in a margin account and not available as working capital,” he says.
“In this case, the FX risk, mitigated with forward contracts, has been replaced with a potential liquidity risk which cannot be taken lightly as now more than ever, cash flow is possibly the most critical challenge facing the corporate treasurer.”
One potential way around this conundrum is to trade via an uncollateralised FX facility so that a treasurer can hedge using forwards and not worry about posting margin. Hutton says some solutions crucially offer this service without jeopardising best execution, ensuring total cost transparency.
With high inflation set to persist throughout the rest of the year, the Fed is expected to continue hiking rates, setting the tone for other major central banks. This tightening of monetary policy is likely to weigh on both global growth and corporate earnings expectations, explains Huttman.
“MilltechFX economists see upside risk to absolute and relative rate pricing in the US. When this is combined with a backdrop of high inflation, slowing growth and tighter liquidity, they see the US dollar continuing to strengthen.”
A stronger dollar is likely to cause more problems for global companies, he says, particularly those that generate revenue overseas and consolidate in the US. As a result, Huttman anticipates a renewed focus and possible increases in hedging by companies with a programme in place.
“Firms which don’t have a formal hedging strategy or rely on ‘natural hedging’ are likely to implement programmes to prevent negative impact from currency volatility on their balance sheets,” he says.