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Risk Management

Companies Cut Financial Hedge Use

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November 03, 2016

Chatham: companies reducing financial hedges despite ongoing uncertainty

Financial RiskEconomic and financial market uncertainty still lingers eight years after the financial crisis upended markets, and yet companies are hedging risk less than they did just a few years ago.

In Chatham Financial’s “2016 State of Financial Risk Management” study released November 1, it found that 97% of analyzed companies have interest rate, currency, and/or commodity risk, and nearly two-thirds of them are using financial hedges for one or more types of risk. Nearly two thirds of the examined companies were manufacturers, followed by professional and business services; trade, transportation and utilities; financial activities, and information. The firm analyzed the financial risk management practices of more than 1500 companies as reported in their 2015 10Ks.

The most common exposure, held by 88% of companies, was to interest-rate risk, although the percentage of firms hedging that risk fell to 32% in the current study, compared to 37% in Chatham’s 2012 study. The number of overall companies using currency and commodity hedges each fell 3%, to 37% and 20%, respectively.

Chatham noted that less use of financial risk management tools coincides with a period of increased volatility in global markets, especially in currencies.

“Given the tremendous levels of volatility in currency markets over the past several years, it's surprising to see that fewer companies are electing to hedge against exposures in this asset class,” said Amol Dhargalkar, managing director of Chatham Financial’s global corporate sector.

Chatham noted that slow growth in Europe, Canada, China and Japan, as well as recessions in Brazil, South Africa and Russia have impacted companies’ ability to forecast swings in FX rates. Consequently, newer entrants to the global markets have delayed implementing hedging strategies. Mr. Dhargalkar said such delays are likely to continue until these companies can more comfortably predict business patterns and make forecasts.

“Unfortunately, this can result in the business being exposed to enormous downside risk as currencies fluctuate, be it from singular ‘shock’ events or longer-term trends,” he said.

Less hedging of interest-rate risk comes as no surprise, Chatham noted, since the zero interest rate policies of many central banks along with negative rates in Japan and across Europe have prompted a decline in hedging activity.

The study found that 75% of larger companies, with annual revenues between $5 billion and $20 billion, had FX exposure while only 58% of firms with revenues between $500 million and $1 billion did. However, just 39% of smaller firms hedged their FX risk while 69% of larger firms did, a discrepancy Chatham attributed to a lack of expertise and dedicated research among smaller companies. Chatham noted that smaller firms tend to have fewer natural hedges against risk in other parts of their business, so volatility can be especially problematic for them.

The study found that 76% of companies are using hedge accounting strategies when they hedge forecasted revenue and expenses, while 80% of companies hedging risk apply hedge accounting to interest-rate derivatives, and 45% to commodity derivatives. Chatham notes that the low percentage of companies applying hedge accounting to commodity hedges stems from the complexity in doing so.

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