Where is the real risk in your FX portfolio and could you measure it if management asked for it? That’s one question that came up during The NeuGroup’s recent FX Managers’ Peer Group Summit, which joined the company’s two FX managers’ peer groups.
Volatility is headline news and coupled with FX impact on corporate reported earnings, it is bound to get attention on the top floor. But is there an overreaction going on? Volatility is high relative to recent years, but in terms of long-term historical highs, not so much. And to take this further, how much of that risk will actually affect your company? And are you spending too much time on things you cannot do anything about, like certain emerging markets? One meeting attendee pointed out that everything depends on what your actual exposures are and where. So with that in mind:
Build a volatility index. Instead of getting too worked up about emerging markets volatility in general, it was recommended that members build a currency index for FX exposures and use it to educate management on how volatile the company really is. “Take your own mix of FX and run historical vols on them and see.” If your index spikes, you can use it as an early warning signal to take action (or change course).
What are the best “pictures” for illustrating risk? What scorecards and charts work best for you? If you’re not happy with them, where do you think they fail? Who should own the risk? In leading the discussion on holistic risk management, one attendee shared his take on “big picture” risk and how to approach it, philosophically and practically. This prompted a debate on objectives, risk ownership and responsibilities. This person pointed out that line management is the ultimate owner of risk, and suggested treasuries resist coming to the line’s aide too readily and for too long. Increase in coffee prices? Raise the price of coffee to the customer. It’s easy to explain and justify. Conversely, if a hedge program prolongs the period between the cost increase and the price increase, that muddies the water on cause and effect (for consumers, sell-side analysts and everyone in between) and relieves line management from some of the responsibility to have sound business practices and react appropriately to market conditions. Each company should, however, determine what the appropriate period of protect ion should be, and it may be industry specific to some degree. Also, “don’t do business with yourself,” i.e., avoid practices such as back-to-back hedges, and other intra-company transactions that are primarily accounting- and not value driven, especially if they at intervals involve real money flows and hedge/trade requirements.
FX risk is viewed “from a holistic perspective” at another member company as well. For this company the hedge program is just one tool in a bigger tool kit. The company encourages the business to reduce foreign exchange exposure by increasing relative proportion of non-USD expenses. However, there are limitations in how fast the exposure can be reduced and how much it can be reduced given the high levels of R&D and USD-denominated parts. In addition, the company also encourages the business to price away the FX risk when the market conditions and regulations allow it. Then it hedges only the remaining risk via their balance sheet and translation programs.
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The two NeuGroups for MNC FX Managers (FXMPG and FXMPG2) convened on March 15-16, and were hosted sponsored by Thomson Reuters (also the meeting sponsor) in New York City. Thomson Reuters updated members on what corporates need to be on the alert for as it relates to the introduction of Europe’s Markets in Financial Instruments Directive (MiFID 2), and also explained the new look of FXall capabilities and trade execution quality analysis (EQA). TR also gave its currency outlook and highlighted the instrument choices supported by some of the Thomson Reuters EIKON heatmap analytics. For more information on the FXMPG1 & 2, please visit www.neugroup.com.