A checklist of benchmark principles to use in developing world-class FX management programs.
From summer 2009 through spring of 2010, members of The NeuGroup’s FX Managers’ Peer Groups 1 and 2 took a comprehensive look at their various FX-related functions and tasks. The result was a list of benchmark principles created from a detailed, multi-part survey and discussed in peer-group meetings that determined what would best describe “World-Class FX” principles and processes.
World Class not universal. The benchmarks are not just a list of laudable goals that are unattainable in the real world. They clearly take into account the resource constraints facing treasuries everywhere in budget, people, skills and systems, as well as business realities like maintaining good banking relationships and controlling counterparty risks in different jurisdictions.
This means being “World Class” is not only a pursuit for the largest companies or those with the most resources. It is a company-specific determination in that World Class is still achievable as long as it represents the best and most efficient effort possible within the individual company’s constraints. Once at this level, only additional resources (in the form of more people, skills, budget, or systems) would permit the company to move to a higher level of World Class.
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WORLD-CLASS FX BENCHMARK PRINCIPLES OF THE NEUGROUP’S FXMPG 1 & 2 |
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| FX Exposure Identification and Monitoring |
A World-Class Exposure Identification and Monitoring Process will provide a strong and effective incentive for the forecast owners to be accurate. This may include (but is not limited to) forecast reviews with treasury or senior management, with penalties for inaccuracy, such as allocation of FX gains and losses to the forecast owner’s results. Clear ownership of forecast accuracy creates accountability to management, which will drive the forecast owner to be aggressive in pursuing it. Collaboration across several departments on exposure identification is ideal, but there needs to be one clear owner. |
| FX Risk Analysis |
A World-Class risk analysis process will use sensitivity analysis, stress testing or value-at-risk calculations frequently to quantify risks based on varying levels of spot rates, forward rates, volatilities, and correlations. Risk analysis calculations should align with company objectives and policies. Risk analysis should be performed in a resource-effective manner, depending on the complexity of the company’s exposures and hedge programs. Management should be informed of risk analysis results frequently so that appropriate actions to minimize the impact of risk can be taken. |
| Centralization of FX Trading and Back-Office |
World-Class Trading and Back-Office Processes will centralize activities to: (1) reduce the number of staff with trading authority and increase control; (2) allow for economies of scale in trading strategies and systems; (3) improve efficiency in back-office operations and increase netting opportunities. The benefits of FX trading centralization should be weighed against the difference in available pricing in different locations. |
| Segregation of Duties | A World-Class Back-Office Process will segregate the duties of confirmation from trading and/or cash settlement. Ideally the trade, confirmer and cash manager should report to separate departments. But at a minimum, different individuals should be responsible for each function. |
| Electronic FX Trading and Confirmations |
Where cost effective, a World-Class Trading Process will utilize electronic platforms for most FX transactions. Companies may elect not to utilize electronic trading platforms, and instead occasionally trade over the phone, if there is a greater business imperative to do so, such as maintaining appropriate bank service levels. Exceptions also need to be made for currency pairs and instruments that are not available on electronic trading platforms, such as non-deliverable forwards. Where electronic trading is not cost-effective or not utilized, competitive phone bids should be sought. Where cost effective, a World-Class Back-Office Process will electronically confirm FX trades for speed, efficiency, reduced risk of error and to generate an audit trail. Confirming electronically is generally better suited for simpler transactions like spot, forward and swap trades than for more complex ones like NDFs, options and collars. |
| Straight-Through Processing from Trade to Accounting |
Where cost effective, a World-Class Trading Process will use straight-through processes where trade data, once entered, will not require manual re-entry. The STP process should free staff to perform higher-value tasks while providing for adequate controls to review, approve and confirm trades. |
| Efficiency |
A World-Class foreign exchange program will operate as efficiently as possible balancing the allocation of resources (people and systems) against the risk from foreign exchange, in alignment with company objectives and policies. Exposures should be ranked in order of risk to the company based on notional value and/or risk-adjusted notional value. Resources should be allocated to exposures in accordance with that ranking, which could mean that immaterial or non-volatile exposures receive little attention and may not be hedged at all. Exposures should be periodically reviewed to ensure resources are allocated appropriately. The cost of implementing systems should be weighed against the frequency and magnitude of errors in manual processes. Manual processes may require more experienced, well-trained staff to mitigate the risk of error. Automated systems cannot fully replace the value added by a motivated and well-trained FX Team. |
| ISDA Agreements | A World-Class Trading Process will theoretically have 100 percent of all non-spot FX transactions covered by ISDA agreements, except for those in currency pairs or countries where ISDA agreements are not standard or not permitted. The ISDA agreement should be negotiated to the company’s advantage to the extent possible, as signing a poorly negotiated ISDA may be worse than having no ISDA at all. In instances where the company has elected not to have an ISDA, or where market conditions prohibit their use, a World-Class treasury will adopt alternate procedures to identify and monitor the risk of not having one. |
| Performance Measurement |
A World-Class performance measurement process will measure the effectiveness of an FX program frequently. Multiple methods may be needed to adequately measure performance, and they should ideally be simple to understand and quick and efficient to calculate. Performance measurement should reflect the goals of the FX program, and assist in identifying its value added. Performance measurement should be performed in a resource-effective manner. Management should be informed of performance measurement results frequently so that changes can be made to improve performance and effectiveness. A World-Class FX program will continually educate all levels of management on the methods and meaning of performance metrics. |
Not World Class yet? Here’s what to do. FXMPG members reported a variety of immediate or planned actions to move the needle on their own performance in the different categories. Some admitted to being far behind the pack in fairly basic things like having a proper treasury management system; understandably for them, it’s a case of “first things first.” For those further along on the World-Class spectrum, work still remained in the most challenging categories. Here are a few items on their agenda:
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Refine the forecast-process ownership; work closer with business units to improve quality;
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Use additional types of risk analysis, like VaR;
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Improve analytics systems capabilities;
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Develop and use new performance metrics.