VOLATILE TIMES: GETTING A GRIP ON RISK
By Rob Daly
Corporate treasurers now have ever-more-sophisticated tools to help get a handle on currency exposures and manage increasingly volatile FX market risk.
“It has been interesting times for currency exchange rates,” notes Vikas Srivastava, manging director, business development, at FX trading solution provider Integral Development. “In the last few years, we’ve seen banks such as Lehman go bankrupt, the Great Recession, craziness in Europe and a few economic upheavals in Asian economies.”
The resulting currency volatility has led to serious consternation for corporate treasurers trying to manage their global FX risk, notes Paul Bramwell, senior vice president, treasury solutions, in SunGard’s corporate liquidity business, pointing to the euro as an example. “There was an expectation that the volatility in Greece and the other PIGS nations—Ireland, Portugal and Spain—was going to unwind the euro.”
Plus, the increased volatility ended the historical correlations between many currency pairs, and with the rising interest in emerging and frontier markets, corporate treasuries cannot get by trading and hedging only the currencies of the most-developed economies—as was common in the 1990s, according to Ivan Asensio, senior vice president, FX risk advisory at HSBC.
“Today, corporate treasuries need to manage their entire portfolio of currencies because no one knows if the Australian dollar, Indian rupee or Turkish lira might be the next currency that materially impacts financial results,” adds Wolfgang Koester, chairman and CEO of FX risk platform vendor FiREapps.
This is the view of Bob Elliott, vice president and assistant treasurer at Eaton—a $21.8 billion global power systems provider that tracks 30 currencies in its portfolio. The treasury organizations in each of Eaton’s regional headquarters—Cleveland, Ohio; São Paulo, Brazil; Morges, Switzerland and Shanghai, China—handle daily interactions with operations in terms of banking, cash management and FX trading, while the Cleveland office handles the company’s global exposure having higher-level conversations on anticipatory hedging, hedging forecast exposure and dealing with responsibilities like setting financial policies and running the commercial paper program, says Elliott.
Eaton pulls its FX exposure data from its Oracle and SAP systems into its SunGard AvantGard Quantum treasury workstation and reviews the information at least monthly, says Elliott. Both data sources run on a monthly closing cycle, he explains. “For certain countries, however, we also have off-line discussions with operations for updates on monthly sales and purchases that become exposed as the month progresses,” he adds. “We tend to do that in daily-rate countries especially, so that we can engage in real-time hedges that line up with the booking rates of those transactions.”
As with many complex business processes, the likelihood of finding a dedicated turnkey application to handle a corporate treasury’s soup-to-nuts FX exposure needs are slim at best. Typically, platforms deliver a few segments of the FX risk lifecycle. Some treasury management system providers offer FX risk management as a native feature rather than an addition—Wall Street Systems’ IT2, for instance—but more often they offer it as an add-on module, like tm5 from Bellin Treasury Software, SunGard’s AvantGard platform and Kyriba’s eponymous enterprise software platform.
Corporate treasurers can also investigate various stand-alone platforms to address particular issues in the currency exposure realm, such as identifying a firm’s global FX risk exposure, valuing FX derivative holdings and identifying netting opportunities. FiREapps, DerivActiv and Integral specialize in those respective tasks.
Bramwell also warns companies to avoid the programming truism of “garbage in, garbage out” by having business units take the time to collect and submit proper forecast numbers. If they do not, there is a chance that the corporate treasury will hedge an FX exposure that may or may not exist. “If a company places a hedge using inaccurate forecast data, it could create a risk exposure instead of hedging one.”
Besides asking for more accurate data, Bramwell sees corporate treasury personnel requesting it more frequently than on the usual weekly basis. “They might be asking for daily reports on the company’s current positions and wanting to know what could happen if there were major changes in the currency markets.”
Eaton does not rely on many bank platforms for FX risk management or trading, but it does rely on a few bank tools to handle transactions at either end of the size spectrum. “We use bank-provided tools for small payments, typically less than $100,000,” says Elliott. “However, our use of such tools is more about getting payments done efficiently than about FX risk management. Conversely, we use algorithmic trading products that the banks provide to make occasional large trades, such as for a pending acquisition, without disrupting the market.”
Global operator Eaton is one of the early adopters of FX trading algorithms, notes Integral’s Srivastava, who has witnessed more corporate treasuries adopting their use in the past two years.
“As treasurers begin to embrace new execution methods, and as new execution mechanisms develop—such as algorithms—we are seeing corporate treasurers begin to show an interest and see how these can help solve their business needs,” agrees Jim Kwiatkowski, global head of transaction sales, marketplaces and financial risk at Thomson Reuters. “As a result, we see growing interest in execution quality analysis that helps the corporate treasurer assess the effectiveness of execution strategies in achieving their FX execution objectives, so that they can adopt these as part of their treasury best practices.”
Bramwell: Most companies will take on that responsibility to make sure the reporting is correct, since there is no benefit in pushing it off to the bank or other authority
Srivastava suggests that, before a treasury exec hits the execute button that sends the algorithmic trade order to the marketplace, corporate FX managers look to see which trades might be netted. “Anything that a company can net internally incurs no transaction cost,” he explains. “When the transactions costs are low, it might not matter as much. When the transaction costs are higher, it matters quite a lot.”
The more broadly a company can look to net, the greater the benefits. Ideally, if a firm could net across all of its FX transactions globally, it would gain the most savings. If a company decides to net transactions at the regional level, it still could witness savings, but just not as much as if it had been done centrally, says Srivastava.
As the FX markets grow more volatile and vendors start offering shiny new platforms to help treasurers cope, Eaton plans to continue managing its exposure in the same way. “We’re focused on how we can use existing tools more efficiently and adapt them better to our needs, more so than having the outside world develop more tools,” says Elliott. But he says they may look at the FiREapps platform to improve their FX risk management process.
One area Eaton would like to improve is managing regulatory change like the Dodd-Frank Act in the US and the EU’s European Market Infrastructure Regulation, which are transforming how the over-the-counter (OTC) derivatives markets operate. Finding the necessary information can be challenging, and Eaton “will fish any hole” to get it, says Elliott.
SunGard’s Bramwell notes: “Depending on a company’s size and its exposure, ultimately it may have to trade through a central trading agency as well rather than trading bilaterally with its bank.” The new rules also require companies to report these trades to an official repository. Bramwell says some banks are willing to submit trade reports on behalf of clients, but the clients would be liable along with their dealers for any reporting errors. “Most companies will take on that responsibility to make sure the reporting is correct, since there is no benefit in pushing it off to the bank or other authority.”
For companies that have been hedging their FX risk with these OTC instruments for a number of years, complying with the new regulations might take some administrative work, HSBC’s Asensio estimates. For those companies that are new to the international market and have not been exposed to these instruments previously, it will add a new layer of administrative requirements and probably take them a little longer to execute their first hedge.
Companies have survived large changes similar to Dodd-Frank, Asensio notes. When every company needed to implement FASB 133 and change how it booked the hedges in its financials, the requirement did not stop firms from hedging, he notes. It just made them change their hedging strategies.