Risk & Economy » Choppy waters or smooth hedge?

Choppy waters or smooth hedge?

Chris Towner, director of independent financial risk management consultancy JCRA, on what finance directors should be looking out for as they start to plan for 2019, which is set to be a very volatile year.

Summer is over. As the nights draw in, for many it means that the countdown towards the end of 2018 has begun. For corporates, it is time to start planning for the year to come. 2019 is shaping up to be an even more uncertain year than 2018. Will the UK crash out of the EU on 29 March with no deal, or will the Chequers proposal be accepted? What are the consequences for UK-based businesses either way?

Making plans to protect revenue and ensure costs are controlled is not easy. If your business imports goods from or exports to the EU – or markets further afield – compounding your forecasting challenge is factoring in volatile exchange rates. What exchange rate assumptions should you plug into your forecast and how do you manage the FX risk to ensure your budget rate is protected?

Drawing from our 30 years’ of experience advising clients globally and across sectors on how to hedge their FX exposure, we have compiled our top 10 tips to address these challenges:

-Set an achievable rather than aspirational budget rate. Use the forward rate plus a ‘buffer’ and don’t engineer the assumed rate from a targeted profit margin.

-Be aware of any existing FX hedges that may be carried over into the new calendar year and how they impact year-end reporting and accounting. Don’t hedge for a single, discrete budget year as this creates a cliff edge and is sub-optimal forecasting

-Analyse the relationship between your business pricing function, such as suppliers and buyers, and your budget exchange rates

-Determine your hedging strategy KPIs and don’t defer thinking about the accounting implications until after the hedge has been executed. For example, in the case of EBITDA protection, hedge accounting is critical.

-Devise a hedging strategy that accommodates the market’s ever-changing dynamics and document your hedging policy to eliminate any subjective judgements regarding timing. This helps you avoid knee-jerk reactions to short-term market fluctuations.

-Evaluate appropriate hedging tools. Those offering 100% protection with some flexibility to cater to changes in cash flows can be very useful. Don’t be lured by products that offer you better than market protection rates as they will involve leverage, extensions or ‘knock-outs’, which can leave your business exposed just when it needs protection the most.

-Ensure the quoted rate from your counterparty is transparent. Your existing relationships won’t always quote you a competitive price. Regulation has attempted to make pricing more transparent but has actually made it more complex. Know that on top of the spot price and forward points come the cost of credit, capital and liquidity.

-Find out how your competitors go about setting their budget rates and try to gain an understanding of what your peer group is doing.

-Before going to market to hedge your net FX risk exposure, always consider any naturally occurring hedging opportunities within your business

-Do seek independent advice – it pays for itself!

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