FX managers also weigh options versus forwards, embedded derivatives in contracts, best practices in trading and execution, and hedging Chinese currency risk.
The FX Managers’ Peer Group kicked off NeuGroup’s first meeting of the second half of 2017 in Chicago by sharing insights on how treasury can improve its ability to measure currency risk, communicate that risk up the chain and hedge the risk. Specific topics included the creation of FX dashboards that more effectively convey FX exposure implications to senior management; the successful use of a software tool by one company to better gauge FX exposures; and the reasons more managers are now leaning against options and toward forwards to hedge exposures. Members also probed the mechanics of hedging exposure to Chinese currency and the CNH vs. CNY debate. And the meeting featured an informative session by sponsor Thomson Reuters on best practices for trading and execution, including a look at the pros and cons of algorithmic trading. At the end of the day, these subjects stood out:
1) An FX Dashboard That Sparks Envy. One member, appropriately from an automaker, wowed the crowd by showing off an FX dashboard developed internally that’s saving time and effort. How can your department do the same?
2) Atlas Lifts Exposure Forecasting. A presentation detailing one member’s use of AtlasFX’s forecasting tool created buzz not only for how it identifies currency exposures but also how it uncovered exposures the company thought existed but turned out to be unsubstantiated. How good are your forecasts?
3) Forwards in Favor. The ebb and flow of market moves as well as currency rate and volatility expectations have shifted the tide toward using forwards over options for many members looking to hedge exposure risk. Are you swimming with or against the tide?
An FX Dashboard That Sparks Envy
One member who works for an automaker impressed her peers—to her surprise—by going under the hood of the company’s FX dashboard, which is being built internally by a data analytics team with no IT budget, using Qlikview, a BI data visualization tool, and Alteryx analytics. The dashboard, now in phase I, provides managers with a single and interactive source for currency exposures, hedge activity, profit impact, market data and indices. It shows FX exposures that allow you to drill down by currency, all in Excel. The drilldowns save this member “a ton of time” to find issues and know who to call, compared to before when lots of research was required to even get that far. The topic clearly hit a nerve with the group, with participants calling the dashboard “super impressive” and one they would like to emulate.
Optimize FX Trading for Best Execution
Best FX execution is a must-have. Thomson Reuters’ Karen Phillips, head of relationship management for transactions, Americas, said new regulations like MiFID II come into effect in an evolving FX market structure where banks faced with higher capital costs are less prone to risk-taking and instead increase their agency trading. Corporate treasurers consequently need execution tools with more transparency so they can “prove” best execution. Advanced methods like algos have grown their role: FXall reports their average daily volume of algo trading has grown 526% from 2014 to July 2017; and almost a quarter of corporates with $50 billion of annual trades or more increasingly use algos for large trades, according to Greenwich Associates. Execution on the platform is available for algos from top liquidity providers, with the analytics required to prove their effectiveness.
Improvements to the FXall platform include: batch trading of up to 200 trades simultaneously to multiple banks for competitive bidding and dynamic provider selection to allow rotation of counterparty banks. FXall users can request execution quality and transaction cost analysis from their relationship managers, and will soon be able to run those reports themselves.
KEY TAKEAWAYS
1) If you have internal resources, use them! Both treasury and senior management win when an internal data analytics team can be tapped to develop a customized solution that, rather than providing yet another report, creates a “one-stop shop” that can answer questions about exposures and their possible impact whenever they arise.
2) Avoid redundancies. The dashboard should provide information that is not already provided via periodic reports. It should also be as close to a real-time snapshot as possible.
3) Tier your audience. In the case presented, there are many potential users of the dashboard but not all users have access to the same level of detail. That way, the right information goes to the right people. Otherwise, you may end up fielding a lot of additional questions from users and creating more work for yourself rather than less.
4) How many users? With a large number of potential users of the dashboard it’s important to consider the licensing or subscription fees of the tools and data feeds you will be using. With a close-to-zero budget, this company made the decision to go with the services mentioned above rather than more expensive options. Also investigate what tools may be included in software subscriptions you are already paying for, such as Power BI in the Microsoft suites.
OUTLOOK
Two-thirds of members say they already have an FX dashboard or have one in development, underscoring the growing interest of treasury in using tools that make use of advances in data visualization to display real-time information to a broad range of stakeholders. But with 80% of members saying their dashboards are still produced with Excel, it’s clear many departments are not yet taking full advantage of the latest technology. This session provided reason for hope that departments that lack IT budget can still create customized dashboards that help provide data and answers about FX exposures and hedges to a wide range of users within the organization.
Atlas Lifts Exposure Forecasting
Another member generated buzz by describing how the company’s adoption of AtlasFX’s software tool for analyzing currency exposure has “greatly improved efficiency” and forecast accuracy. The importance of accuracy is highlighted by one of the company’s hedge objectives: to remove the impact of FX fluctuations from the business lines by using internal hedges. But corporate does not retain the impact; it is pushed down to the business; so, if the forecasts are inaccurate, the FX impact goes on the BUs’ books. Atlas interfaces with SAP and Reval to “seamlessly obtain key data inputs that drive forecasted exposures and hedge amount recommendations.” Translation: Atlas has taken a lot of pressure off treasury and the business. It didn’t surprise the member that Atlas picked up exposures the company wasn’t reporting; but it did surprise him that Atlas uncovered some exposures being reported unnecessarily. The presentation included a controller at one business unit saying, “I’m really looking forward to when Atlas is fully operational as it will liberate our scarce resources by allowing more time for analysis with less time spent on data preparation.”
Avoiding the Dreaded Embedded Derivative
Treasury’s risk management mandate is challenged by contract clauses that are meant to share risk between contractual partners but trigger embedded derivatives that need to be identified and marked-to-market. Service companies, for example, may price in the client’s currency but incur delivery costs in another currency due to resources based in another country. A group member structures contracts to either take on the FX risk fully (for a higher price); transfer the risk to the client (lower price) or share the risk (hybrid). Treasury is closely involved in contract-level FX advisory: the global policy requires treasury pre-approval before structuring a contract with any non-functional currency pricing and/or invoicing. The company provides the deal teams ongoing education on the impact of contract structures, and has several tools to smooth this process, including a deal-review website and form as well as standard contract language to minimize occurrences of certain clause types. Next up, treasury works closely with finance functions and CIO to implement digitalization of firm-wide pricing tools by automating the FX risk identification associated with the treasury policy review process.
KEY TAKEAWAYS
1) Exposure ID can get better—for real! Treasury departments dissatisfied with their current system for tracking exposures have worthwhile options to explore other than Excel or homegrown approaches. In addition to improved accuracy, the presenting member reports reducing the time to make monthly forecasts from three days to one by eliminating “arduous, low-value tasks.”
2) Tier your currencies in the FX policy. While not strictly on the exposure ID process topic, the presenter also mentioned his company tiers the currencies in its policy into those that are routinely hedged and those that are not (but can be). Twelve tier 1 currencies are hedged out up to four years in accordance with the regular hedge program. Tier 2 are the 16 currencies where the exposures are too immaterial or too expensive to hedge. The tiers should be reviewed and reassessed regularly. The advantage of putting them in a policy is that it takes the additional analysis out of whether they should be hedged or not (until the next review).
OUTLOOK
Producing 100% accuracy in FX exposure forecasts may not be realistic; but the improvements in accuracy and efficiency achieved by members using new tools like the software designed by Atlas provide more evidence that treasury stands to gain by at least investing the time to explore its options. Then you can decide if spending the money to gain access to tools that have passed the test set by other companies makes good business sense for your organization.
Forwards in Favor
Members discussing risk management strategy voiced an increasing support and preference for the use of forwards over options to hedge currency risk, with one presenter saying, “there is a place for options, just not today.” Slides on the subject elaborated on the market math supporting that conclusion, ending with the takeaway: “Current climate does not suit use of options for OpEx” (operating expenses, the subject of a recent review by treasury). Another member described his decision to use a layered hedging strategy using average rate forwards over three years with the goal of reducing volatility to 3% from the 5% it achieved using options. His presentation included results of a Citibank survey that included this takeaway: “Often FX hedge program execution, results and measurement do not support the stated goal of the organization, resulting in unnecessary FX volatility.” Another member echoed the trend, saying his bias for options has decreased given recent moves in the dollar and that back-testing revealed forwards have been better at reducing earnings volatility.
Is Everybody Switching to CNH?
What is the better way to hedge Chinese exposures, economically and sustainably over a longer period: CNH or offshore non-deliverable forwards (NDFs)? Faced with increasing non-capex exposures in China from business growth, a member needs to decide how to best hedge what until recently was an exposure that wasn’t hedged because of immateriality and the high cost of hedging, and decide on a potential switch from CNY NDFs to CNH to hedge long-dated (up to three years) CNY exposures. Several members are still using NDFs but some are using both. With the CNH market growing in size and ease of execution, and the basis differential between the two markets small or even favoring the NDF market for now (depending on the direction of your exposures, of course), it is not a straightforward choice. Liquidity beyond a year’s tenor is another problem, but one which may abate over time. For now, the member has decided to stick with NDFs and extend the tenor, even though his banks have said they will price out both currencies.
KEY TAKEAWAYS
1) Prepare to pivot. Treasury must constantly question strategic approaches to hedging risk and be prepared to pivot to alternative tools when market circumstances change and in the face of research that challenges old assumptions.
2) While you’re at it, reassess your layering frequency too. One member is currently layering hedges monthly but is considering going to a quarterly layering approach as the analysis they have done shows they would get almost the same volatility reduction, and it would save time and transaction costs.
OUTLOOK
Premium costs for options are a major factor for treasurers deciding how to best hedge risk and, at this meeting, the pendulum among members seems to have swung in the direction of forwards for a variety of reasons. Looking ahead, another key factor for treasury to consider in this perennial debate will be the adoption of new hedge accounting rules that are generally seen to make options less attractive when weighing the impact to the income statement.