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ctc guide FX Risk Management: The Right Steps for a New Era ctc guide FX Risk M

ctc guide FX Risk Management: The Right Steps for a New Era ctc guide FX Risk Management: The Right Steps for a New Era How the evolution of FX programs and market uncertainty are driving a new way of looking at risk. By Nilly Essaides Contents Overview Page 1 Why Now? Page 2 The Current State of U.S. Corporate Hedging Page 4 The Spectrum of Risk Management Programs Page 5 Case Studies Case Study 1: $40 billion Multinational Page 8 Case Study 2: Privately Owned U.S. Multinational Page 9 Case Study 3: $25 billion Multinational Page 11 Case Study 4: Newly Public Multinational Page 14 Case Study 5: Airline and FX Commodity Exposures Page 17 Case Study 6: Privately Held Canadian Multinational Page 20 The Disconnect Page 22 How to Build an Effective Program Page 25 Conclusion Page 28 www.AFPonline.org ©2012 Association for Financial Professionals, Inc. All Rights Reserved 1 CTC GUIDE: Corporate FX Risk Management Overview Foreign exchange risk is not a new issue for today’s orga nizations. Multinationals have struggled with it for years. However, the current financial and economic environment presents new challenges and opportunities, and they are triggering a reexamination of the way corporations manage their currency exposures. This is welcome news. There are several reasons why currency risk is getting more attention—and not all of them are positive. What comes to mind first, of course, is the sharp decline of the euro. That, combined with the European debt crisis, has had a negative impact on the earnings of U.S.-based multinationals. The impact was evident in the many disappointing second-quarter 2012 earnings reports, and companies blamed the stronger dollar for substantial hits to their earnings per share (EPS). The media is also play ing a role in the increased focus on currency risk. There have been numerous front-page stories about derivatives’ “losses.” While those media reports typically offer a one- sided view of the use of derivatives, those stories unfortu nately tend to get the attention of Boards of Directors. In addition, impending financial regulations are likely to change the way companies manage all sorts of risk, including currency exposure, primarily by making derivatives more expensive to trade and documentation more burdensome. Specifically, new capital require ments for banks under the international regulatory framework known as Basel III, and new rules under the Dodd-Frank legislation in the U.S. are going to affect how much banks charge for products, access and ease of credit, and the kinds of reporting requirements with which companies will need to comply for some common risk management strategies. But these may just be the “headline” reasons behind the greater emphasis on currency exposure. Experts in terviewed for this guide point to a broader trend toward a systematic reevaluation of the substance and process of risk management. Specifically, they note treasury’s growing role as a strategic partner and how its greater involvement with an organization’s operations is allowing companies to do a better job at identifying their true economic exposures. Additionally, constantly evolving treasury technology is finally reaching some critical mass. Many companies still rely on Excel spreadsheets to track exposures and manage their risk management programs; however more are implementing treasury management systems (TMS) or niche applications, to handle the various steps in the risk-management process including exposure identifica tion, risk analysis, trading and post-trade accounting and reporting. The availability of new tools, many of them provided on a more affordable Software as a Service (SaaS) basis and as portals (vs. installed applications), is making it possible for companies to manage risk in a more cost-effective way. Still, there continues to be a big disconnect between what market experts say companies should do and what they actually do. This disconnect is evident in the six case studies in this report. This could be due in part just to timing: corporate policies evolve slowly while the markets move at a lightning pace. But much of it also is due to how management perceives risk, skewed corporate incen tives and non-existent currency risk management perfor mance metrics. Those things need to change. “It’s a new ballgame,” said Craig Martin, Executive Director of AFP’s Corporate Treasurers Council. “[The recent rise in the dollar] is turning FX risk management on its head.” The fact that the dollar seems poised for a secular trend reversal is providing corporate risk managers with a unique opportunity to spearhead much-needed change. “CFOs used to consider foreign exchange (FX) risk management an operational issue,” said Ramon Bauza, Managing Director and Head of FX Risk Advisory with Deutsche Bank. But FX has shot up to the top of the list of strategic concerns. Bauza said he’s had more conversa tions with CFOs in the past few months than he’s had in the past five years. Also helping to spur change in FX risk management is treasury’s elevated profile with senior management and Boards. “Prior to the credit crunch of 2008, treasury was relatively underappreciated,” said Robert Baldoni, who heads Ernst & Young’s Global T reasury Advisory Practice. The sharp emphasis on liquidity changed that perception. “T reasurers are in front of senior managements and Boards now much more often,” Baldoni said. “T reasury is more visible and its contribution is more appreciated.” “[The recent rise in the dollar] is turning FX risk management on its head.” 2 ©2012 Association for Financial Professionals, Inc. All Rights Reserved www.AFPonline.org CTC GUIDE: Corporate FX Risk Management Why Now? The experts interviewed for this guide listed several drivers that have combined to bring extra focus to FX risk management. The stronger U.S. dollar The dollar is up sharply since the start of the year, and there are plenty of dollar “bulls” out there. For U.S.-based companies, this is a double-whammy. Their euro income is translating into fewer dollars just as sales in the euro-zone are taking a dip. While Europe no longer represents the greatest source of growth for U.S. companies, it remains the greatest source of exposure, according to Ivan Asensio, Head of FX Risk Advisory & Sales Structuring, HSBC Americas. “The declining currency and increase in political risk in the euro-zone has driven a lot of risk management interest.” Impending regulations “Regulations will impact companies in a way that’s not easily foreseeable at the moment,” said Amol Dhargalkar, Managing Director, Risk Management for Chatham Fi nancial. While most companies have not yet made many changes, regulations under Dodd-Frank will affect some more sophisticated treasury practices, such as the use of back-to-back trades with treasury centers. Meanwhile, “Basel III is the biggest thing that will impact corporate hedging in general,” said the risk advisory professional at a large U.S. bank. “It will re ally change everything in a big way, and the banks are basically planning their futures based on very conserva tive capital requirements.” He predicted most banks will require margins for any forwards out further than 12 months. Even if companies do get a formal ex emption, added the assistant treasurer at a large U.S. multinational corporation, the exemption would apply only to spot and short-term forwards, not options and non-deliverable forwards. “The costs of maintaining a program will go up,” Dhargalkar agreed. Increased market volatility “Tremendous volatility is driving the growing inter est in FX,” said Joe Siu, Director, Risk Management for Corporates, and Dhargalkar’s colleague at Chatham. “Black swan” events have become more common Source: Chatham Financial www.AFPonline.org ©2012 Association for Financial Professionals, Inc. All Rights Reserved 3 CTC GUIDE: Corporate FX Risk Management “Black Swan” events, those one in 100-year market shocks, are happening much more often “You’ve got to make sure your risk management program is top-notch. Best-in-class treasuries are thinking ahead. A program may have worked in the current environment, but organizations need to be faster and smarter in the use of resources in the next environment,” noted Siu. Information is flowing faster. “The cost of being wrong is higher because the speed with which info [sic] is being transmitted is faster,” Dhargalkar cautioned. “If the CFO knows before you do that there’s an onshore vs. offshore market for China, that’s not being viewed as acceptable.” CFOs simply have much more access to information. This puts the onus on treasury to keep up and keep CFOs informed. “Treasurers need to be ahead.” Not all the drivers spurring more emphasis on FX risk management are negative. There are also positive developments. Treasurers are taking a leading role in their organizations. Experts like E&Y’s Baldoni’s and Jacqui Drew, Senior Solution Consultant at Reval, explained that the treasury organization is gaining new ground. “Treasurers are driving more projects to compare actual performance against risk management policy,” reported Drew. She said Reval has noticed a definite uptick in the number of companies re-evaluating their approach. “The driver, more often than not, has been the trea surer. “There is very senior management asking for his/ her opinion.” Technology is offering greater visibility and control. “While the [euro-zone] crisis may have been the immediate impetus,” Drew said, she sees a broader trend: companies are uploads/Management/ ctc-guide-fx.pdf