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Risk Management

Risks of an FX Hedging Program Stuck in the Past

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September 11, 2019

Financial RiskTreasurers at multinational corporations with long-standing currency hedging programs may find themselves questioning whether strategies put in place years ago still make sense, given changes in a company’s geographic footprint, supply chain and business model. That’s the challenge facing one member of the Treasurers’ Group of Mega-Caps, who worries that the manufacturer she works for is “stuck in the past” when it comes to its hedging program.

The facts. The company hedges cash-flow exposures to reduce earnings volatility and revises its forecast several times a year, the treasurer explained. Its standard practice is to hedge FX exposures with intercompany sales from the US parent company to international affiliates. But as the company has reduced its economic risk by transitioning to more regionalized sources of supply, it has also removed the underlying exposures that have created hedge accounting capacity. Experts say this underscores that while isolated operational changes can mitigate risk, they may also create unintended consequences for the company’s full hedging needs.

Added complexity. The company also wants to hedge its balance sheet exposure, using derivatives to offset the risk of nonfunctional currency receivables and payables that are subject to revaluation. The treasurer said juggling all of these elements is difficult, in part because “it’s super challenging to get a consolidated view of exposures.” That’s a theme echoed by treasurers and assistant treasurers throughout the NeuGroup Network. This treasurer said that without sufficient visibility to exposures, she wonders if the hedging program will “help the company or create more P&L impact or disrupt natural hedging positions.”

The path ahead. Asked what changes the company is exploring to improve its FX risk management, the treasurer said the company is considering:

  1. Reassessing its hedging objectives.
  2. Consolidating its exposures into select entities to make hedging more feasible.
  3. Reviewing its functional currency selections for certain legal entities—potentially moving to USD functional currency.
  4. Simplifying its processes, including exposure collection and intercompany transactions.

Set it and forget it? The larger issue here is one familiar to Jamie Weaver, head of the accounting advisory team at Chatham Financial, who says he sees plenty of companies that have a “set it and forget it approach” to their hedging programs. The problem with focusing on an isolated set of economic or accounting exposures, he said, is that companies “lose the big picture view,” fail to capture the company’s “true economic footprint,” and don’t account for potentially significant changes in their foreign subsidiary operations. That can leave a company underhedged or over-hedged, depending on a multitude of factors.

A better view. Companies confronting these “absolutely confusing and challenging” issues may want to take a “zoomed-out view of the big picture” to make sure their hedging strategy is prioritizing what’s most important to achieving the company’s goals, said Amanda Breslin, head of Chatham’s corporate treasury advisory group. Some companies may find consultants can help do a periodic deep dive as a company’s risk profile evolves to dissect the flows and to devise a hedging program that makes sense today, she said.

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