MTFX_Hedging Processes_2017
- 1. Summary&Highlights • The sudden bout of volatility has resulted in large losses for Canadian importers • The need for a sound hedging policy irrespective of the external environment is becoming ever so important. • 2017 will be an opportune time for Canadian importer and exporters to look at how they manage FX and put in place risk identification, aggregation and management policies. • Not hedging is speculation which is likely to result in greater exposures an larger losses. • The establishment of a robust hedging policy, setting up of a strong intra-company risk reporting framework and proactive management are the keys to managing FX exposure. The Importance of FX Risk Management The sharp increase volatility in USD/CAD since late 2014 had caught several Canadian importers by surprise after a few years of rather range bound activity in this currency pair. The sharp move lower to beyond 1.45 in Q1 2016 and the equally fast reversal back to the 1.30 level, wrong footed several corporates again. One can say that Canadian importers were not really at fault as the currency has traded in a rather narrow range of 1.1239 to 0.9739 for a period of about 62 months from Q2 2009 to Q3 2014 with a standard deviation of 56 pips. This period of low volatility was preceded by a period during the financial crisis in 2007 to 2009 when it traded in a volatile range with nearly twice the standard deviation of 97 bps. In Q4 2014, the crude oil price fell sharply after OPEC resisted calls for a cut in production at their November meeting.The steep fall in crude oil prices which constitutes about 20-25% of Canadian exports resulted in a consequential fall in the Canadian Dollar.The surprise rate cut from Bank of Canada in Jan 2015 added to volatility. In Q4 2014, the crude oil price fell sharp- ly after OPEC resisted calls for a cut in production at their November meeting. The steep fall in crude oil prices which constitutes about 20-25% of Canadian exports resulted in a conse- quential fall in the Canadian Dollar. The surprise rate cut from Bank of Canada in Jan 2015 added to volatility. dealing.desk@mtfxgroup.comCA Dealing Desk: 1.800.832.5104 US Dealing Desk: 1.855.663.6839 select products that support your needs Select execute the strategy evaluate your results and adjust Execute Evaluate set budget and goals create a risk management policy identify your FX exposure Budget Plan Research
- 2. This sudden bout of volatility resulted in large losses for Cana- dian importers and reinforced the need for a sound hedging policy irrespective of the external environment. The lesson learned from this sudden surge of volatility is that a sound and structured program of FX hedging will not result in huge losses during periods of excessive volatility, but at the same time not hedging during periods of low volatility would not have provided excessive returns. This is an opportune time for Canadian importers and export- ers to look at how they manage FX risk and put in place a proper risk identification, aggregation and management policy. In 2017 we have volatility emanating from crude oil prices and change in US policies. Risk Identification - is the starting point of the hedging process and it is often said“well begun is half done.” The origi- nation of FX exposures in a typical corporate occurs far away from the confines of the corporate treasury department & done at times with no inputs from this team. The CFO needs to ensure that operations (including purchasing) & sales take inputs from the Corporate Treasurer for pricing of input & output. The onus is on the corporate treasury team to ensure that proper reporting of foreign exchange denominated purchases or sales are done in a timely manner. The corporate treasury department needs to have a say in the pricing of these imported or exported items so that the pricing is right given the current and expected trend in exchange rates. This gives the corporate treasurer early visibility of exposures and his team can use their expertise to mitigate this exchange risk. This is one of the weakest links in the risk management process and it is not uncommon to hear the finance department say that they just got hit by this payment request in a foreign currency from a certain part of the organization. The key is to establish strong lines of communication with the departments within the company where the foreign exchange risk origi- nates and have a structured system of transmitting this infor- dealing.desk@mtfxgroup.comCA Dealing Desk: 1.800.832.5104 US Dealing Desk: 1.855.663.6839 mation to the corporate treasury department which will then assume responsibility of managing the risk in this. Risk Aggregation - Once the reporting of the FX Risk has been conveyed, the responsibility of managing this falls on the lap of the corporate treasurer, in smaller organizations the CFO himself may oversee this, while the day to day manage- ment is delegated to one of the senior finance professionals within the company. The objective of centralized manage- ment works well for diversified companies which operate from multiple geographies and have offices and plants for different product lines. The first step that the corporate treasurer needs to undertake is to check whether there are offsetting flows within the company that mitigate the risks. Even when offsetting risks are present, there could be timing mismatches that need to be managed. This can be done by using holding accounts in foreign currencies. The corporate treasurer could also discuss with the respective user depart- ments possibilities of prepayments of commitments which could result in cash discounts. Risk Management -The objective of a corporate treasurer is to mitigate the risk at the earliest moment and not to take risks in the market. Not hedging is speculation By not putting hedges in place, the corporate treasurer will expose the company to market risks which could result in big losses. There is never a good or bad rate to hedge at. Hedging is the process of locking in costs for imports or realized local currency amounts for exports. A well-defined hedging policy takes out the emotional quotient from the decision of when to hedge and makes this process more structured, which will result in good long term risk man- agement culture within the organization and will not be hostage to the whims and fancies of people who run the finance department from time to time. Whether markets are volatile or placid it is a prudent practice to hedge FX exposures as soon as they are crystallized and it
- 3. dealing.desk@mtfxgroup.comCA Dealing Desk: 1.800.832.5104 U.S. Dealing Desk: 1.855.663.6839 can be done with a combination of Spot, Forwards & Holding Accounts using a portfolio approach to hedging. The objec- tive of such hedging is to ensure that the budget rate is protected at all times. Once the Forex Risks have been elimi- nated by establishing a robust hedging policy, excess man- agement time will not be spent on tracking markets and that will free up time for focusing on the core business. Hedging gives management breathing time (as current & short term business are protected) to adjust to changes that impact core business in case of large FX movements. Why MTFX? It is important to keep the Hedging process simple and make use of FX Spot & Forward contracts to hedge FX exposures. We offer transparent pricing and you can place market orders or watch levels which will be monitored in our systems. Our dealers will proactively work with you to help achieve your objective. Our exchange rates are better than what any bank can offer as this is the only business we do and being competitive on rates has helped us sustain and grow since 1996. The use of forward foreign exchange contracts also reduces the complexities involved in hedge accounting, ensuring that management time is not spent on complex calculations and discussions with auditors regarding compliance to hedge accounting norms. We offer quotes on over 100 currency pairs and our state of art technology platform will integrate seamlessly into your enterprise resource planning or in-house treasury system. We offer multi-currency holding accounts which can be used to park currencies for use as and when required. A dedicated account management team at hand will focus on implementation, training and support. Summary & Conclusion: The establishment of a robust hedging policy, setting up of strong intra-company risk reporting framework and proactive involvement of the corporate treasurer even before the crystallization of the FX exposure will go a long way to build a sustainable FX risk management framework. Contact Us Office Address Global Headquarters Telephone & Fax Dealing Desk: +905.305.9023 Toll Free: 1.800.832.5104 Fax: 1.866.206.1740 2750 14th Avenue, Suite 306 Markham, ON Canada L3R 0B6 U.S. Headquarters Office Address Telephone & Fax Dealing Desk: +201.435.6839 Fax: 1.866.206.1740 2500 Plaza 5, 25th Floor Harborside Financial Center Jersey City, NJ 07311 Toll Free: 1.855.663.6839