FX Mambo Number 5

Click here to view the results of the 2023 EACT Survey

In the latest EACT survey of corporate treasurers, market risk, including of course FX risk and commodity risk, was found to be the number five priority of European multinational companies.

Of course, this ranking should come as no surprise. We focus here on the main points of attention that treasurers should consider in the coming months. The most important one (linked to the priority of priorities according to treasurers) is the forecasting of foreign currency cash flows (in this case). The key words are "uncertainty" and "correlation". Add to this the impact of swap points because of rising currency rates, the lack of strategy or outdated strategies, over-reliance on spreadsheets and (overly) manual processes and finally inter-company financing. These are the priorities that need to be considered.

The triple forecast of treasury: 1-3-5

The order of priorities is interesting because if the risk of change (FX) and commodity comes in fifth place. Change or renewal of IT systems is third and implies a revision of the treasury IT solutions in place (i.e., TMS), which are often old, somewhat obsolete, and incomplete (and therefore highly manual for processes that can be automated). And finally, cash-flow forecasting comes in first place, as usual, we are tempted to say. Having accurate, fair, and therefore properly hedged forecasts of future currency flows is a common goal for most companies. The EACT survey makes this clear.

With these shared observations, let's reflect on what we should consider more specifically:

• Business and the economy are uncertain, and risks are around every corner. Vigilance is needed more than ever.
• Elements are increasingly correlated and interdependent, making decisions more complicated and the need for hedging more necessary, when trading margins are under pressure.
• The impact of swap points can be significant on certain currency pairs.
• Strategies need to be reviewed when outdated, too old or inefficient (in line with the tools in place).
• Intercompany financing must not be forgotten and hedged too.
• Tools are available to automate processes to free up the treasurer, increase efficiency and internal controls while reducing costs. Filling in the parts that are still too manual and agreeing on areas for improvement is essential to generate value, especially for operations.

This should be our FX agenda for the coming months.

Turning a threat into an asset

Crises are always opportunities to review processes and a holistic approach to the matter can only be advised. In times of total uncertainty and multi-crises, where anything can happen, it is advisable to be equipped and to fasten the belt in case of turbulence. The beauty of the subject is that CMA (i.e., Currency Management Automation) technology allows you to be better covered and offload the hedges, which are ultimately quite mechanical and not very rewarding mentally. Risks arrive 24/7 but are only processed 8/5 (unfortunately), with a possible time lag on top generating potential FX losses. The result can only be imperfect and unsatisfactory. The art is to transform the trial by automating a notch higher. Let's batten down the hatches of error-prone manual processes. Today, interdependence or total correlation means that everything is linked, and one element can shake up the hyper-sensitive currency markets.

If there was a first piece of advice, it would be to hedge more and earlier. A strategy can only be applied consistently if it is applied systematically. Nowadays, political events can impact the whole economy, a "green swan" can stop all activity or a ship across a channel can disrupt world trade. We have even seen with the GBP flash crashes, extreme daily volatilities and movements in all directions. The elements plead for more rigor and systematism in the strategies applied. Unfortunately, risks are no longer managed in silos, but in herds. A complete overhaul of foreign exchange management is therefore required to optimize it in the face of the new challenges that lie ahead.

FX roadmapping

Priorities have already been mentioned: once the new strategy has been reviewed and adjusted, it is important to determine the hedging program(s) that are adapted to the objectives. For example:

• A program to manage the systematic hedging of foreign currency invoices if they were not already hedged during an off-balance sheet commitment – the so-called "firm commitment".
• A program to dynamically manage hedges and conditional prices via automated corridors - to limit negative carry, to mitigate the impact of swap points or, on the contrary, an aggressive hedge to benefit from swap points - to benefit from positive carry, depending on their direction.
• Automatically set the management of stop losses or buy orders according to fixed and adjusted levels, without having to constantly call your banker.
• Successive layers of hedging – regular action phases to adjust a predefined FX campaign, a business seasonality, a rush, or unexpected business factor impacting sales, a budget... or a combination of programs depending on the underlying business.
• Taking advantage of natural or unnatural netting.
• Automated gradual hedging to match "in" or "out" flows forecasted as soon as a change is identified.
• Collateral management on CSA-type agreements to benefit from much lower hedging costs (given collateral granted to banker).
• Precise monitoring of hedging performance through automation and KPIs.
• Not to mention IFRS 9 reports often produced in XL for lack of an efficient TMS.
• Etc.

As you can see, it is possible to act on different levers and at different times, without the intervention of humans via CMA solutions. It is easy to understand that this new form of management allows to improve the price of operations and to make the company more competitive. In addition to helping the business, the treasurer can also make the company more resilient, less sensitive to the risk of human error or fraud, quicker to react to limit any movement in the opposite direction, strengthen internal controls, free up the treasurer's time who has better things to do than to "deal" on foreign exchange platforms and bring people together in the company to develop the "partnering" so often hoped for. This requires a better understanding of the underlying business to better understand and hedge it. This is a new approach that is recommended and has become "best practice". We can only encourage treasurers to question the management of foreign exchange to boost financial and operational results. The treasurer will then become a true creator of value, adored by all.

François Masquelier, CEO of Simply Treasury – Luxembourg – May 2023

_{Disclaimer: This article was prepared by François Masquelier in his personal capacity. The opinion expressed in this article are the author’s own and do not necessarily reflect the view of the European Association of Corporate Treasurers (EACT)}