Could treasurers be exposed to FX risks?

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The increasing complexity of the FX market is causing treasurers to look ever more closely at the exposure to the risks involved.

 

Three areas are impacting on this. The impact of Fintech; governments’ increasing concern about interest rates and employment levels; and the new global regulatory changes. All of these will affect hedging strategy.

 

FinTech

 

Few treasurers need telling about the complexities of ERP and they will be aware of the exposure to FX risks. Automated systems are routinely used to reduce this, but they too need to be monitored reducing the lack of transparency around exposure. As platforms such as Facebook, Twitter and Linkedin offer share buttons, an understanding of the market becomes ever more complex.

 

The lack of regulation of platforms is an added problem and the failure of manual exposure identification adds to treasurers’ headaches.

 

Updating internal systems is key to solving the problem by providing the tools to forensically examine ERP systems. Despite automation, treasurers must still make quick decisions when following real-time movements in the currency markets. An overall view of the issues can help to identify a potential issue and hedge it onto a lengthier period. However, it is possible for a particular risk to go unnoticed in a department before it is hedged, opening the door to substantial losses.

 

Automation remains the best way to avoid this, especially if the treasury department keeps a keen eye on data. Indeed, it should free up time to deal with other issues, ensuring that an overall view of finances is available. This provides a thorough understanding of the company’s business model, meaning treasurers have time for trend analysis in the FX market.

 

Regulation

 

Scrutiny of the market means that demonstrating best practice is essential for any treasury department, and regulation can constrain liquidity. The most successful departments will be those which can show the best execution of analysis of their FX transactions by reviewing actual data and improving strategy based thereon.

 

Evaluating currency trades paired, size and time of execution, counterpart activity, response times and spreads are key.

 

An understanding of the tightening regulation of the FX market will be essential for any treasurer, and the global alignment of the rules is moving apace. Differences in relation to FX forwards, depending on settlement delivery dates, is an area of concern for FX deals.

 

Allegations of manipulation of the FX markets have reminded some of the Libor scandal and Finma, the Swiss regulator has continued to express concern. The introduction of MiFIDII means that the lighter touch of regulation which the FX market has enjoyed is in the past in Europe and the other regulatory authorities are set to tighten their own rules.

 

Hedging is an area where treasurers find it hard to buck the tradition of hedging immediate risk. Such a rolling hedge may have unintended consequences. The company may be locked into forward rates, in addition to which a hedge may not cover the entire exposure and reduce credit capacity. Layered hedging may offer a solution, taking a longer-term view of the FX market. Although this may prove more difficult to execute Fintech solutions are available.

 

Looking to the future, there is little doubt the FX market will be more structured and regulated, and all market users will be affected. With this comes the potential for constraints on liquidity.

 

Currency fluctuation, mentioned above, and the costs of hedging will exacerbate FX risk management and any programmes the treasury department uses. Constantly re-evaluating strategies and tools and FX policy on transactions and risk will be essential during 2018 if the challenges ahead are to be navigated.

 

Getting extra value is the aim of all treasury departments, and FX hedges are one of the most obvious ways of adding small improvements on the balance sheet if evaluated regularly. Making time to do this and developing a good working relationship with a banking partner can help.

 

As ever, the FX market is one of the most complex areas with which a treasurer will have to deal. Furthermore, the impact of FinTech and regulatory changes has made it even more complex. Adopting a more proactive approach to this challenging market will continue to place demands upon treasurers around the world.

 

Simon Lynch is the owner of Treasury Talent.

Treasury Talent is a specialist treasury talent provider solely focussed on the treasury market with offices in Sydney covering Australia, Singapore covering Asia, and San Francisco covering California and the USA. To make contact simon@treasurytalent.net

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