Foreign Exchange (FX) Risk Management in Corporate Treasury

You’re doing business internationally — are your FX risk strategies up to the job? Operating overseas always creates some type of risk, whether that arises from unexpected currency rate fluctuations or having foreign assets on your balance sheet. But not managing embedded risk appropriately could cause future headaches for treasurers. Taking proactive steps, like putting the right framework and policies in place and automating FX risk management, can help.

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Identifying and measuring risk is key. For example, if you’re going to price an item in local currency, you’ll be exposed to currency fluctuations that could impact your bottom line. Or if you’re selling overseas in dollars, your sales price will fluctuate in local currency causing exposure for your clients with implications on the demand for your products compared to local competition. However you operate, you need to know what your exposure is and how to manage it, which requires a comprehensive risk management program. For this to be successful, you’ll need to build the right infrastructure, and technology will be a fundamental driver of the process.

Implement measurable, realistic policies and procedures that align with your business objectives.
Define how risk will be evaluated and over what time frame.
Identify and measure your risk and decide whether you want to mitigate it.
Choose how you want to hedge the risk.
Manage associated tasks — for example, if you execute a derivative you’ll need to manage derivative reporting.

Every company can benefit from a risk management system, whether that’s an in-house system or one from a third-party provider. It gives you greater transparency around your FX exposures and allows you to run comprehensive analysis. When evaluating what you need to help you manage FX risk, there are five main areas to consider:

Enterprise Resource Planning (ERP) and a Treasury Management System (TMS)

Your ERP and/or TMS systems can be useful tools for FX risk management. The ERP helps you understand your exposure by giving you a view into all your balance sheet items in aggregate. The TMS is used in addition to an ERP to help you centralize and manage your treasury accounts and processes globally, providing visibility and control over global FX activity. For example, if you have intercompany activity that would require netting, a TMS may help with that. Finding the right providers for your ERP and TMS needs establishes the necessary infrastructure to successfully manage your global treasury processes.

Risk analytics
Whether or not you utilize your ERP or TMS systems for FX risk management, finding actionable risk insights can help ensure the financial health of your business. Risk analytics use sophisticated modeling and scenario analysis to evaluate FX risk. You can either run this in-house or through a third-party system. These offerings normally integrate directly with your ERP and/or TMS or can be an additional module within them. Either way, they provide the necessary insights so that you can develop hedging strategies and implement risk mitigation measures. It’s also something that banking providers offer, with clients providing data so that simulations can be run that estimate how much future cashflow they could lose or gain due to FX exposure. This provides a baseline for making decisions about whether it’s significant enough to warrant managing that risk through FX hedging.
Execution
If you decide to hedge your risk, thinking upfront about how you are going to trade is key. For example, how frequently will you be trading — will it be 100 trades a day or three trades a month? What kind of controls do you want to have on the types of instruments that will be used, the tenor of hedges, and the individuals that will be able to trade and approve? How can you best manage the confirmation process and the future settlement of the trade? This will influence the channels you use, such as traditional voice trading, single bank or multibank eFX offerings, or transactional FX solutions. Normally, one size does not fit all and companies manage multiple execution paths.
Exposure Management Reporting
Once you have a clear view of your overall exposures, you can identify whether you need to employ derivatives. If the answer is yes, then valuation and hedge tracking become very important. It’s something a third party can help with. Whether you execute your hedges with a single provider or multiple, they can offer comprehensive tracking across all of them.
Outsourcing
Banking providers have different levels of outsourcing services, from exposure advisory expertise to a complete package of transactional FX and embedded risk management solutions.

Some banking providers have begun to offer alternative risk management solutions to derivatives such as providing fixed FX rates for a predetermined period of time. This provides users the benefit of managing the associated FX risk without having to undertake the operational burden of a full-fledged risk management program.

The best way to manage risk in FX treasury operations is to identify your exposure and put the right framework in place, whether that means developing your own technology capabilities or harnessing the strengths of a third party. To find out more about the approaches mentioned here, contact your Bank of America representative or visit our FX Treasury Solutions webpage.