Risk & Economy » Corporates are not out of the woods when it comes to FX volatility

Corporates are not out of the woods when it comes to FX volatility

FX volatility may have calmed in recent months, but managing the threat of currency movements remains a top priority for CFOs. Eric Huttman, CEO at FX-as-a-Service provider MillTechFX, discusses how firms are adapting their FX hedging strategies in the face of economic uncertainty and the steps they can take to protect their bottom lines.

Foreign exchange (FX) risk management has risen to the top of the agenda for many senior-finance decision makers at corporates over the course of 2023.

This is particularly the case for North American firms transacting in the US dollar who, according to Kyriba’s July 2023 Currency Impact Report, reported $21.24 billion in FX headwinds in Q1 2023 – up 45% from the same time last year.

While firms are likely to welcome the recent drop in FX volatility, it is vital that they don’t become complacent. With uncertainty set to stay, corporates need to adapt their FX risk management strategies to stay ahead of the curve.

The changing face of hedging

 Eric Huttman, CEO at MillTechFX

According to MillTechFX’s own 2023 CFO FX survey, over two-thirds (68%) of North American firms have experienced heightened FX risk as a result of US dollar volatility.

Corporate treasurers are subsequently renewing their focus on hedging, with 81% having a formal hedging program in place. Out of the 19% that do not, almost seven out of ten (69%) are considering implementing one.

CFOs are typically hedging a higher amount of their exposure to increase their protection. MillTechFX’s survey found that the average hedge ratio was between 60% – 69%, with nearly eight out of ten (79%) corporates citing this as higher compared to this time last year.

Similarly, many are now locking in rates of six months or less with the average length of hedges at five and a half months. This suggests that corporates are opting for shorter hedge lengths to add an extra layer of nimbleness and flexibility should the market move against them, enabling firms to adjust their exposure if they need to.

An interesting dynamic is that over three-quarters of firms report that the cost of hedging has increased over the past year. This means that looking ahead, corporate treasurers should consider balancing the cost of hedging against the risk of not hedging and the potential impact this may have on the bottom line.

Out with the old, in with the new

Despite the renewed focus on managing the threat of currency movements, a third of corporates rate their FX set-up as below average or worst in class.

One of the main reasons for this is the persistence of manual legacy systems which can be extremely cumbersome and inefficient. Our survey found that 40% of corporate treasurers have to manually send or upload files for instructing financial transactions, with 35% relying on phone and 34% on email.

FX price discovery can often involve multiple phone calls, e-mails or online platforms to log in to just to get a quote from your counterparties. If it is best rate wins, because the market moves by the half second, price discovery requires a team of people calling, e-mailing and logging in simultaneously before they can collectively decide who offered the best quote.

Price discovery is just the first step in the FX booking process. After a rate is booked in, trade confirmations usually arrive by e-mail. Settlement must then be processed, payment details entered and checked and approval from different layers of seniority can be required.

All of this internal, manual and siloed communication is extremely inefficient. And this is just for one, single trade. Many organisations execute tens or hundreds of trades every month with different products and mechanics, making the entire process a huge drain on time and resources. Corporate treasury teams spend on average 2.31 days per week on FX-related matters, while 72% have three or more people tasked with FX activities.

It is therefore unsurprising that 81% of corporate treasurers looking into new technology and platforms to automate their FX operations.

Certainty in an uncertain environment

Much of the recent focus has been on whether volatility will resurge during the second half of 2023, but the more important factor at play is the uncertain economic outlook itself.

Hedging currency risk is one of the primary ways that firms can mitigate the risk posed by this uncertain climate, and while there will always be some that do not hedge their FX risk at all, many are now considering doing so to protect their bottom lines.

Looking ahead throughout the rest of 2023 and beyond, getting the right processes in now and implementing alternative technology-driven solutions that can help manage FX risk more effectively will be key in navigating the challenges that lie ahead.

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