After two years of firefighting during the pandemic, treasurers could be forgiven for sighing wearily over the flurry of macro shocks and geopolitical uncertainties that have marked 2022 and, moreover, are likely to stretch out over the next year.
The challenges presented by these shocks, on the face of it, are even more formidable for treasurers considering many do not have first-hand experience of managing risk in such a volatile, uncertain environment, according to Amol Dhargalkar, managing partner and chairman at US-based financial risk manager Chatham Financial.
“There are not a lot of people in corporates who were sitting in the same seats 40 years ago when we last saw CPI hit current levels, and it’s been over 20 years since we saw such a strong dollar,” says Dhargalkar.
“Whether it’s in the US, the UK, eurozone, or elsewhere, it is something most will have not seen, including treasurers, CFOs and most board members. So, in that sense what we are going through is a generational challenge.”
But rather than being fearful of their limitations, Dhargalkar sees treasurers rising to the challenge. Indeed, he senses a marked increase in the visibility treasurers now have within organisations.
“It’s when crises like these happen that treasury teams get their moment in the sun,” he adds. “And while they’d prefer not to have too many crises, what we’re seeing is, across the entire industry, that the most forward-thinking treasurers, the most strategic ones, are using this as an opportunity to both educate and shape the future of their organisations across many different areas.”
Yet, at the very time treasurers are being feted for their skills and expertise, companies in the US are increasingly coming up against problems with staffing and recruitment of treasurers – an issue Dhargalkar says he has not come across before in his 20-year career.
Effective hedging programmes to mitigate the impact of high inflation and a rampant US dollar are a top priority for corporates but Dhargalkar says US companies are struggling to implement them due to a shortage of treasurers and high staff turnover.
“We have had so many companies that want to run new hedging programmes, or maintain existing ones, but they’ve run into the problem of how they can actually operationally do so as they have lost key staff through retirement or moves into other roles. The market for treasurers is very competitive now.”
Even if the broader job market in the economy declines going forward, he fully expects demand for specialised skills such as treasury to remain high.
Focus on rate hedging
With one of the fastest ever hiking cycles by the US Federal Reserve currently in train, the problems US companies are having recruiting treasurers could not have come at a worse time. Only last week the Fed implemented its second consecutive 0.75-point rate rise to 2.25% to combat inflation, which is running at 9.1%, the highest since 1981.
Companies fortunate to have stable treasury teams are being highly proactive with their hedging, focusing on several primary hedges, rates being foremost. Dhargalkar says: “Companies that have floating rate debt exposure have been aggressively looking at how to reduce that primarily by swapping their debt to fixed, mostly on their term loans.
“Not surprisingly, the rates that they’re locking in at now are often much higher than the rates we saw just a few months ago but it is at least providing them with certainty that it won’t get materially worse than that.”
With less leveraged companies, Chatham is seeing a focus on mitigating rate risk associated with future bond issuances, typically by entering into pre-issuance hedges to lock in current rates.
“Here too though current rates are not as good as they were just a few months ago, but they’re materially better than what people are afraid they might be looking ahead,” he says.
While swaps and pre-issuance hedging are the two main strategies, Chatham is also seeing significant activity with cross currency swaps. These are agreements to exchange cash flows in one currency for cash flows in another currency at defined rates. As such cross-currency swaps have both FX and rate elements.
“Swapping into euro has been quite popular among multinationals, for instance,” says Dhargalkar. “Companies can save 150 to 200 basis points on their interest expense, depending on their tenor. And it means they might be more able to enter into cross currency swaps versus undertaking debt issuance, particularly given the state of [the] eurozone’s capital markets.
“The US is expected to move much more aggressively than the eurozone in particular on interest rates. And that interest rate differential is still very interesting for companies to exploit through cross currency swaps. One of the big benefits of cross currency swaps for US multinationals, especially in the current environment, is they are flexible and fast to action – they can be implemented in a day or two.”
Commodity hedging demand soars
Commodities are currently one of the big drivers of inflation, making them another important target for hedging. Indeed, such is the concern over the outlook for commodities that Dhargalkar says that over his 20-year career in finance he has never seen such a high level of demand for commodities hedging from treasurers and CFOs, beyond what they might ordinarily action within their procurement or supply chain processes.
One of the big challenges with commodity hedging, especially in the current macro and geopolitical environment, is that suppliers may not be willing to go out very far into the future, or they may not offer the best pricing in view of the uncertainties with supply and demand. At Chatham, Dhargalkar and his colleagues are seeing large companies with turnover greater than a quarter of a billion dollars looking for commodities solutions in addition to their usual supplier hedging programs. OTC derivatives are proving especially popular for a wide range of needs, whether for fuel, energy or metals.
“The OTC market offers much more flexibility and potentially better pricing because it’s more transparent than is the case with suppliers. In the US we have seen auto manufacturers and their suppliers engaging in metals hedging programs much more, and for a wider range of metals over the last 12 -18 months,” he says.
Compared to rates hedging, commodities hedging can be much more challenging, according to Dhargalkar: “If you are the treasurer or CFOs managing rates, everything you need is within your domain, including the capital structure. But when it comes to commodities, you don’t get to sit in your silo within treasury and finance. You have to delve much deeper into the business units working with the supply chain, but also with financial planning and analysis and your international businesses not to mention dealing with accounting and tax implications of a hedging strategy.
“There’s just so much more that commodities hedging requires. It is the most team sport of all the sports that treasurers have to play. Treasurers can lead the charge but they’re not going to be very effective if they’re the only one. It takes a lot of energy to get commodities hedging up and running, as well as time – weeks if not months.”
FX hedging for a strong dollar
Effective FX hedging is another priority for CFOs and treasurers, with a strong US dollar eating into the profits of US multinationals. Companies that have established, effective FX programmes are feeling good about themselves, but even they are asking if they are doing everything they can and continually reviewing the effectiveness of their strategy and its cost.
Dhargalkar cites the experience of one company, which has had costs for its balance sheet hedging programme for protecting FX-denominated assets and liabilities jump from around $100,000 a month to $1m a month.
“Suddenly that company is looking at annualize costs of $10m-$12m,” he says. “That’s a very meaningful impact on margins. For companies like that, there is a risk-return trade-off. If the cost is that high then they could choose not to hedge certain currencies, for example, or choose to hedge them a little bit less.”