If the focus is on whether a hedge will make or lose money, then risk management can too easily be put aside.
A good hedging program aspires to reduce the company’s risk. But sometimes companies can lose sight of that aspiration if they start thinking about whether that hedge will make or lose money. And if that’s the case, companies often choose the route of doing nothing at all.
“Since companies cannot insure success by always making money on their hedges, the simpler alternative is to avoid losses (and the accompanying second-guessing) by not doing very much hedging,” writes Matthew Daniel, a director in Citi’s Corporate Solutions Group, in a letter to clients.
The problem of looking at hedges as money makers or losers is that it’s too narrow a view and usually doesn’t comply with the overall objectives of the company. One way to broaden management’s view of hedging programs – and its acceptance, according to Mr. Daniel, is through communication. Communication and education is critical because without a management or Board that is up to speed on a hedge program – the mechanics and the purpose – treasurers can find themselves answering a lot of unproductive questions about why the company is hedging in the first place.
To that end, treasury needs to proselytize about hedging; get out and educate with meetings and other tools to make the company aware of what’s being done. “The why of your risk management should be obvious,” Mr. Daniel writes. “If it’s not, then start scheduling meetings with business managers and your senior management.” According to Citi, the education effort should:
- Attempt to define the company’s overall strategies and objectives,
- Establish whether outside investors and analysts are focused on a particular aspect of your financial results, and;
- Illustrate how risk management can play a role in meeting those objectives.
But communication should be two-way. Treasurers need to know what management and the Board is thinking by asking tough questions. For example:
- Is the company more concerned with protecting cash flows or earnings?
- What capacity does the company have for absorbing shocks to its business results over time?
- If you have recently gone through a policy review and did not actively engage senior management in questions about why, then start over.
- If you are planning on beginning a project to reassess your risk management program, then make sure this is a major part of the process.
Management should pay attention.The education component cannot be overstated. During the financial crisis, companies collectively suffered losses in the billions, mainly because they were entering into fairly complex FX derivative contracts and had lax oversight – that is, management didn’t have a full understanding of what the company was doing to hedge risk. According to Satyajit Das, author of “Extreme Money,” as many as 50,000 companies in at least 12 countries lost nearly $530 billion (see related story here).