As currency volatility has spiked in recent months, we'vealso seen a spike in the impact that currency swings are having oncorporate earnings. In the “2016 Global Foreign Exchange Survey,”which Deloitte released in March, the firm predicts that levels ofuncertainty in foreign exchange (FX) will remain high throughoutthis year.

The survey asked corporate treasurers and treasury professionalsaround the world, in organizations with US$1 billion or more inannual revenue, about how they're managing currency risk. Itidentified some critical areas for improvement in corporate FX riskmanagement practices in preparation for the ongoing volatility.

Treasury & Risk sat down with NiklasBergentoft, director of global treasury advisory services atDeloitte & Touche LLP, and Richard Brooks, specialist leader inthe global treasury advisory services group, to discuss the surveyresults, as well as what companies should be doing to improve theirtreasury function's ability to manage currency risk moreeffectively.

T&R: What are some of the keytake-aways from Deloitte's “2016 Global Foreign ExchangeSurvey”?

Niklas Bergentoft: The survey is tellingus that there are clearly some challenges around how companiesmanage FX risk, and that there is a disconnect between how treasuryfunctions manage currency risk and what their boards areexpecting.

More than one-third of respondents [37 percent] feel theirboards are not getting the information they need about FXexposures. We saw that and we asked ourselves: What would boards doif they had different information? How would boards react if theycould see the FX impact on earnings or gross margins? We think thatthey would set the expectation that the treasurer of theorganization needs to take a more active role in getting close tothe business in order to understand exposures and drive bettervisibility into exposures.

T&R: In the survey, more thanhalf of respondents said their corporate treasury team lacksvisibility into FX exposures. (See Figure 1, on page 2.) Does this gibe with what you see in thereal world?

NB: Yes. In our global treasury survey a year and a half ago, we foundthat 50 percent of companies had challenges with visibility intotheir FX exposures. This year, we're seeing that 56 percent can'tclearly and reliably see their exposures. And that explains why somany U.S.-based corporations are taking big hits on their earnings due to currency impacts. It'spretty simple to see what's going on: If companies can't clearlysee it, they can't manage it.

It's also pretty clear where exposures are originating in thecompany—it tends to be at the front lines of the business. FX risksare cropping up whenever the sales force structures a sales dealthat has a currency component. They're arising when the procurementfunction is acquiring materials in a foreign currency. And theinformation that treasury is receiving from these other functionsis not enabling them to accurately estimate the size and timing ofcompany's FX risks.

When the treasury department doesn't understand how and when thebusiness is generating foreign exchange exposures, that reallyimpacts their ability to effectively manage the impact of thoseexposures on margins, and hence on the results.

T&R: Figure 1 also showsthat 33 percent of treasury functions have troubleunderstanding the business. What should the corporate treasurer inthese companies be doing differently?

NB: The way you go about addressing thatis looking at how you manage FX risk, and transforming theoperating model so you get treasury more embedded with the wholesupply chain. By doing a better job of partnering with thebusiness, treasury is going to get better visibility and understandthe company's FX exposures better. By educating and holding thefront line of the business accountable for their actions and theircurrency impacts to the bottom line, treasury can drive improvedaccuracy in the exposure forecast.

Richard Brooks: The other aspect to thisis that treasury needs to do a better job of managing thecommercial effectiveness of currency hedging programs. They need tomeasure the effectiveness of the exposure data that the businessunits are providing, by comparing forecasts to actuals in order tounderstand volumetric risk in the forecasts. And the businessesneed to be accountable for forecast error.

T&R: Your survey shows that 89percent of companies are using derivatives to manage their FX risk.For the exposures they do have adequate visibility into, are thesetreasuries hedging effectively?

NB: Well, fewer than half of thecompanies we surveyed are managing FX against some type of measureof commercial effectiveness, such as looking at the impact on grossmargins or other profitability measures. And only 15 percent doanalysis on stress tests and scenario planning. [See Figure 2, on page 3.] Very few companies assess what variancesof FX forecasts to actuals mean to the bottom line and thecommercial effectiveness of their hedging programs.

RB: And it's worth noting that if you dothe forecast-to-actual comparison around the effectiveness of yourhedging programs, that will improve the business's understanding ofFX and how currency issues impact their business. It will give themincentive to do a better job with their forecasts.

T&R: Is the best practice, then,for treasury to compare actuals to forecast and then just sharethat information with the business? Or are there other thingstreasury should do to improve forecast accuracy?

RB: Well, treasury certainly needs tohave a dialogue with the business around understanding theforecasts and exposures, and making sure there aren't any risksthat aren't captured in the exposure data they receive. Part ofthat conversation needs to be validating the results and where theforecast errors are. So information needs to be provided to thebusinesses, but there needs to be dialogue around that to keepimprovements in forecast accuracy moving forward.

NB: The treasurers of organizations areonly as effective as the information they have and the role they'retaking throughout the organization. And boards can take a moreactive role in setting that expectation. The treasurer's roleshould be to drive visibility into the exposures and forecasts, andto do that, they need to understand the business.

In fact, we think boards should be challenging their treasuryteams more. And treasury has an excellent opportunity here. 2015was a very tough market, especially for U.S.-based corporations, interms of currency impact. This year, currency markets continue tobe challenging. So there's an opportunity for treasury departmentsto step up and become more of a strategic adviser to the board.That's a role they really should be playing.

But as boards challenge treasury to take on a more strategicrole, they should also be properly investing in the tools thattreasury needs to do a better job of analyzing FX exposurescompanywide. Treasury departments have been under-invested in forway too long. It's not fair to expect treasury departments tomanage FX risk effectively without the right investment in thefunction. Now is a good time for treasurers to make a case for thevalue of transforming the way the organization manages FX risk.

T&R: And this investment ismostly in treasury technologies?

NB: Technology is not the entire answer, but it's important. Our surveyalso found that, among the companies that can actually see their FXexposures, half gather the data manually. The information-gatheringis slow, which means treasury doesn't have the information rightaway, which in turn reduces hedging effectiveness. By getting theright investment in technology, treasury departments can providemore robust reporting and constantly look for opportunities tocreate value.

At the same time, treasurers need to start speaking the samelanguage as the board, and really look at FX from more of acommercially effective perspective, in light of continued businessgrowth and profitability.

Treasury departments need to take this opportunity to demand theright investment in their function, in their capabilities, in theirpeople, in their tools, and in their technologies. Because it's apretty clear-cut business case these days.

T&R: What information shouldtreasury be reporting to the board about FX risk, and howoften?

NB: It varies, of course, depending onhow much currency risk the company faces.

RB: Figure 2 is very interesting in termsof the level of information corporate boards are currently gettingaround foreign currency exposures; the information is very basic.It's mostly an exposure summary, FX gains and losses, and coverageratios. Those reports don't provide sufficient detail for the boardto see where FX is really impacting the business—top line, bottomline, balance sheet risks—and how effective hedging programs are.There's not enough granularity and detail.

One key component of reporting to the board is to have theappropriate benchmark for measuring the commercial effectiveness ofyour hedging programs, and that includes linking the results of theprogram to your profit margins or an earnings per share metric, orother financial measure that the business will understand in termsof impact of FX volatility on the financial results.

In addition to that performance benchmark, it's important togauge how effective hedging programs are by measuring thevolumetric risk vs. the price risk. So you want to separate outwhere you have a forecast error as a source of ineffectiveness,compared with how performance has done when you look at thebenchmark rate vs. your hedge rate.

T&R: Is it also important toprovide the board with results of stress testing and scenarioplanning analyses?

RB: Yes, those are important as well. Alot of the stress tests you typically see being done and reportedon answer pretty basic questions like 'If foreign currency marketsmove up or down 10 percent against the dollar, what does thatequate to in terms of percentage impact to the business or toprofits overall?'

Treasury functions could do more to provide additionalgranularity around scenarios where some currencies may be moving ina favorable direction, while others are moving in an unfavorabledirection, and looking at the impact of those currency moves onconsolidated earnings and cash flows.

NB: Almost two-thirds of our surveyrespondents think they're doing a pretty good job of reporting tothe board on currency risks. But overall the reporting that's beingdone is fairly basic. The least-popular activities on Figure2—stress testing and scenario analysis, and benchmarking impacts tometrics like earnings per share and gross margin—are the approachesthat take a more forward-looking view on the exposures. Reportingthat to senior management would be more impactful than some of theactivities that a larger proportion of treasury teams are currentlyengaging in.

T&R: Why is the typical treasuryfunction not providing the board with this type ofinformation?

RB: Well, treasuries are not receivingthe quality and granularity of data that they would need to improvereporting around FX. And I think for many companies, the reason whytreasury hasn't historically received the FX information it shouldis that up until about two years ago, the dollar was depreciatingagainst major currencies, which meant there was always a benefit asforeign earnings were translated back into U.S. dollar equivalents.So even when there was volatility and noise in currency impacts oncompanies' bottom line, it was beneficial volatility and noise, asopposed to the current environment where it's detrimental. So thattook some pressure off treasuries.

Nowthat we're in a more volatile world and the dollar's strengthening,I think we're going to see more boards asking their treasurers toimprove the analytic explanation around how FX impactsfinancials.

NB: And if they aren't doing that, theyshould be.

T&R: What steps should treasurerstake to determine the right level of reporting of FX risk to theirboard?

NB: The treasury team just needs to makesure they're looking at currency risk from the perspective of howFX will impact gross margin. They need to look at otherprofitability measures too, and to look at smoothing year on year.If they do that and have the right KPIs in place, that approachwill drive to a view of the currency impact on earnings pershare.

When treasury is looking at FX risk in this way, theconversation with the board and senior managers will be betteraligned. And frankly, it'll also be more aligned with how theinvestor community and analysts are looking at FX risk when theylook at the value of the company.

T&R: Your survey also found that28 percent of companies use two sources to quantify FX exposures,and 31 percent use three or more sources. What is the best practicein terms of gathering this information?

RB: This is one of the key challengesaround visibility to FX risks—manual exposure-capture processes.When global companies are on multiple ERP systems, they havemultiple sources of FX information that needs to be provided totreasury. The more complicated a company's treasury systemsinfrastructure, the more likely it is that treasury will be relianton the business to manually provide information about FX risk.

NB: I agree; that's a recurring theme.Even our 2015 survey showed that using multiple sources of FXinformation was a big challenge. As you mentioned, in this year'ssurvey, 59 percent of respondents said their company uses two ormore sources of information. That certainly makes it more difficultto collate all the FX exposures.

If you're looking at what companies need to do, from aninfrastructure perspective, they need to focus on eithersimplifying their finance infrastructure or, at a minimum,achieving real-time integration of different systems. And thenfocus on the data quality and consistency from these differentsources in order to drive visibility and reduce inaccuracy.

T&R: In your survey, only 58percent of respondents are managing risk through natural hedgesthat match costs and revenue across the same currency in the sameentity. Would increasing natural risk mitigation be another benefitof improving FX information?

RB: Yes, definitely. Most treasuryfunctions have an opportunity to do a better job of finding naturaloffsets of exposures. Only 46 percent of survey respondents arecurrently using those natural hedges across entities, or throughnetting of exposures.

This is especially important in emerging markets. AsFigure 1 indicates, volatility in restricted-currency marketshas really moved up the list in terms of being a top concern fortreasurers. A lot of companies have become more international. Morethan half of our survey respondents do business in 20 or morecountries. And a lot of revenue growth for multinationals is inemerging-market countries. Most treasuries are using derivatives tomanage their exposures. But in emerging markets, it's not always ascost-effective—or necessarily even possible—to use derivatives tomanage your risks. So alternatives such as natural managementtechniques may be a solution in these markets.

NB: This also supports the idea thattreasury should be making the case for better technology solutions.When we have more than half of surveyed companies operating in 20or more countries, and 62 percent of respondents are receivingmanual FX forecasts from their business units, clearly theautomation of currency forecasts and analysis of currency risk aretwo key areas that corporations need to develop.

T&R: Are these conversations thatmany corporate treasurers are currently having with their boardsand senior management?

NB: Some companies are having thesedialogues and are driving a pretty hard line around this. They'rejustifying investment in treasury by the FX impact the company isexperiencing. But I don't believe enough companies are doing that.Given the massive hits U.S.-based corporations have taken over thepast year, and are likely to continue to take, this is somethingthat most organizations should be looking at.