By Anne Friberg
Quarter after quarter of negative impact on results due to US dollar strengthening elevates the issue to the board level and prompts a focus on metrics and hedge refinement.
FX risk management has moved up to a shared number 1 priority (along with capital planning) in fall 2015 among members of The NeuGroup’s US-based treasurer-level peer groups; and for good reason. This is up from number 5 in 2014, which was before the near decade-long dollar-weakening trend reversed course. As a result, the vast majority of US corporates in NeuGroup surveys say they’ve seen at least slightly and in many cases extremely negative effects on their reported financials, attracting attention of the C-suite and board, and prompting a shift in treasury’s management of FX, or at least a review of the efficacy and messaging around FX programs.
Unsurprisingly, the latter has influenced agenda choices for our FX groups. In 2016, we’ll continue discussions on the outcomes of those reviews, but also in what other ways FX managers can add value to their companies, for example by elevating the awareness of FX risk and actions outside of treasury that make companies more FX fluctuation-resilient.
Dollar Peak Years Away?
Among the banks that contributed to our peer discussions in 2015, there is agreement that the dollar is several years away from peaking. BNP Paribas noted the dollar’s rise has been unusually sharp although still (as of September) 9 percent off its 2002 peak, leading it to believe the next peak could be 2 to 3 years away.
Citi, meanwhile, said it expects the dollar to keep strengthening for 3 to 6 years, in part due to a strong US economy and higher interest rates (vs. Europe and Japan), declining commodity prices, and emerging markets instability.
Utilize Policy Flexibility, or Build In More
Across The NeuGroups, the dominating goal of FX programs is either protecting cash flows from FX fluctuations or a combination of protecting cash-flow and earnings volatility. With the dollar’s rise, programs in place have proven less effective at delivering on those objectives, as evidenced by earnings releases showing negative effects of FX. As a result, companies in our network have undertaken wholesale or partial reviews of their risk approaches to gauge how they have performed and how they can be improved. One company back-tested its multi-year program with a focus on hedge layering over the exposure period and subsequently made changes to the layer proportions and timing. Many others have similarly made adjustments either to increase hedge ratios earlier on, or extend hedge horizons, or a combination of both, some with a view to being opportunistic (e.g., to lock in favorable rates). The latter may require a policy change for some, but many already have some of that flexibility built in. This flexibility also helps should the dollar trend reverse again.
Not Only What You Say But How You Say It
When investors take note of negative events, so does the board. Consequently, FX teams are likely fighting several fires simultaneously: eliminating misunderstandings at the board level about risk metrics and mitigation (and how that is not necessarily better done at other companies—this is where peer-to-peer benchmarking is valuable), and providing relevant qualitative and quantitative information to communicate results to external stakeholders and equity analysts in a way that separates business performance from FX impact. This explains why more companies now show some performance metrics in “constant dollars” (holding FX rates for comparative periods constant to isolate KPIs like revenue growth). Related to this, KPIs for FX risk management should be approved by the board to avoid any disconnect between FX team objectives and board expectations.
Communication efforts should also include “speaking one language” internally about how risk is defined and measured. One member company is going through an exposure and sensitivity framework exercise to develop just one, consistent way of calculating exposure and using sensitivity analysis in such a way that the leadership can be presented with clear choices on levels of acceptable risk and costs of managing to those levels.
Best Practice: FX Thinking Business-wide
We see more and more treasuries not only managing exposures as they are but also working with the business to educate them on FX and its impact on results, and be part of the business decision process. A member of the FXMPG recently updated her peers on efforts to integrate FX exposure awareness into strategic decision making, for example, long-term planning of manufacturing locations. We expect to see more “silo-breaking” like that going forward.