By Matthew N. Daniel, Wells Fargo Foreign Exchange Risk Management Group
As more companies do business internationally, foreign exchange (FX) takes on greater importance. Currency fluctuations can impact everything from your revenue and earnings to your stock values.
Yet despite its significance, five out of six organizations are unable to quantify their FX exposures. These same companies cite four major challenges to their overall FX abilities: lack of data on exposures, market volatility, knowing what strategy to use, and knowing when to hedge.1
A top-down approach can help take the pain out of your FX risk management. It can strengthen your relationship with C-level and board stakeholders, and give you objective metrics to gauge the effectiveness of your FX activities.
Support your C-suite with data and information
Begin your risk management process by gathering information about your exposures. Be proactive and initiate conversations with line of business heads, financial planning and analysis (FP&A), and your treasury counterparts in other locations, with the goal of identifying and quantifying your exposures.
- Within your organization, what functional currencies do various entities use?
- What currencies do you use to buy, sell, borrow, or lend?
- In what amounts and timeframes?
- How will FX rates affect customer and supplier contracts, or pricing and sourcing decisions?
- What financial information is available for ongoing FX decision-making and measurement?
Current, accurate, and easily accessible data is the Holy Grail for FX managers. However, the less centralized your treasury structure and systems, the more difficult it can be to obtain. Identify where disparate systems, local decision-making, or other obstacles limit your visibility, so your organization can invest in the infrastructure needed for optimal FX management.
With data in hand, quantify your potential risk. Begin with what you have — even if you only have partial exposure data or if it is based on estimates. Take time to educate your C-suite stakeholders and board members on how changes in FX rates affect your organization’s financial metrics. It is also essential that senior management understand any constraints relating to hedge costs, restrictions imposed by meeting the requirements to achieve hedge accounting, or access to data that might limit your ability to manage these risks effectively.
Align FX with your business priorities
Too often, corporate FX programs begin and end with how you will hedge your risk. Entering too quickly into hedge contracts and prematurely defining hedge horizons skips the critical step of why it’s important that your organization manage FX risk in the first place.
As you gather the information you need to identify and quantify potential risks as a part of the process of developing a risk management policy, begin meeting with your senior leadership to agree on — and document — your key business priorities. Just as your global footprint is unique, so will your goals be specific to your organization. For example, a manufacturing firm might need to reduce the year-over-year impact of currency fluctuations on revenue. A publicly traded company might focus on more accurate quarterly forecasts for analysts and shareholders. A tech startup might face rapid short-term expansion that requires investment capital for foreign acquisitions.
Having clear direction will eliminate ad hoc hedging decisions. It also reduces finger-pointing and frustration by removing subjectivity from performance measurement.
Help senior leaders tell your FX story
Lastly, take an active role as the “FX advocate” within your company. Learn what your C-suite needs so they can tell the company’s FX story to internal and external stakeholders, then make a plan to provide this information on a regular basis.
- Who are the most important audiences?
- What time periods are important to measure?
- How do your FX tools — such as forwards, options, or even unhedged exposures — link back to your business priorities?
This format gives you a template for updates, where you can indicate where rate fluctuations or other events impacted your performance, discuss the effect to your business, and recommend the next steps. Using a narrative approach gives your stakeholders the context and clarity they need to discuss FX intelligently, and make smart business decisions.
1. Wells Fargo, 2016 Risk Management Practices Survey