Volatility in the foreign exchange markets has become agreater concern for finance professionals over the past year,according to the annual risk survey released by the Association for FinancialProfessionals.

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Thirty percent of the 335 finance professionals whom the AFPsurveyed listed currency risk as one of their top five concerns, upfrom just 16% who cited it as a top concern in last year's survey.Currency risk was the fourth-highest–ranked concern in the 2016survey, following only political and regulatory uncertainty, whichwas cited by 43%; tougher competition (42%); and customersatisfaction and retention (40%).

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“It's interesting that currency volatility made it into the topfive for the first time,” said Craig Martin, executive director ofAFP's Corporate Treasurers Council. “Thehit to earnings from currency translation losses has certainlybeen a factor in multinationals' earnings for well over a yearnow.”

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Martin noted that more and more U.S. companies have begun tooperate internationally over the past five years. “It's new tothem, and they've found themselves in a much more difficultposition, especially with the shifts going on in the globaleconomy,” he said.

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More than half (52%) of the respondents said their company facesgreater earnings uncertainty now than it did three years ago, andthe most frequently cited driver was financial factors includinginterest rates and currencies.

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In the AFP survey, 54% of respondents said their companies has ahedge program in place to deal with interest rate, FX, or commodityrisks, and 24% said they are beginning to implement a hedgeprogram.

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Martin said that given the extent of the volatility in financialmarkets, the proportion of companies with hedge programs in placeis “disappointingly low.”

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Revamping Hedging Programs

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Amol Dhargalkar, a managing director at financial riskmanagement company Chatham Financial, said he's seen “a prettysignificant number of companies that are really looking to revamptheir existing [hedging] programs.”

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A survey of 350 executives which Chatham conducted during arecent webinar showed that about a third of companies areconsidering making improvements in their hedging programs over thenext six months, he said. Those programs hedge FX, interest rate,and commodity exposures.

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“Certainly on the FX side, we've seen a lot of companies tryingto move into different ways of hedging their exposure,” Dhargalkarsaid.

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One area companies are looking at is translation risk, whichinvolves the effect of foreign exchange movements on a company's balancesheet as foreign business units' financials aretranslated into the parent company's functional currency. “We'veworked with a number of companies that are very focused on thattranslation impact of the dollar strengthening,” he said.

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One of the biggest problems is that companies can't use hedgeaccounting if they hedge translation risk.

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Given that obstacle, “there might be different strategies that acompany can apply from a hedge that can mimic translation hedging,”Dhargalkar said. “That's something we've spent a lot of time withclients around.

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“I'd say a pretty low percentage of companies today are doing[translation hedging], but it's a higher percentage today than itwas a year ago and much, much higher than two years ago,” headded.

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The AFP survey showed that among companies hedging interestrates, swaps are the most popular instrument, while forwards areused most frequently to hedge FX risks. The report also citedincreased interest in using options to hedge financialrisks.

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But Ryan Gaylor, vice president of client sales and midmarket atReval, a provider of treasury and risk management solutions, saidthe appeal of options has faded.

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“The longer the volatility persists and trends in a singledirection, the more that volatility is priced into the premiums ofthe options, which then makes them less favorable,” Gaylor said.“In general, most corporates prefer using straightforwards.”

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Commodity Risk

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Dhargalkar noted companies' concern about commodities prices,with almost a third of the executives surveyed during Chatham'swebinar citing commodity price volatility as their highest concern.

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“We actually have seen a lot of companies try to dig into theircommodities exposures,” he said. “One of the challenges is thecommodity exposure may be managed, not necessarily within treasurybut maybe within the procurement function.”

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The most important thing is for companies to get a handle ontheir exposures, Dhargalkar said.

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“For those companies that aren't hedging their commodity riskbut know they have a significant amount of commodity risk, that'swhere to start,” he said. “Get everyone in the room and decide howyou can take advantage of the prices where they are now.”

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Reval's Gaylor said that many corporates find it more difficultto implement a commodity hedging program than programs to hedgeother asset classes, such as currency and interest rates. There ismore complexity, including collateral management, counterparty riskand cost basis. In addition, “overall, it's harder to prove out theeffectiveness of that hedge,” he said. But Gaylor noted that arevised international accounting standard, IFRS 9, and a tentativeFinancial Accounting Standards Board decision on component hedging,may make it easier to prove the effectiveness of commodityhedges.

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“There's a number of different customers that have been lookingat commodity hedging programs for a while,” Gaylor added, and saidthat with commodity prices at low levels, “for those seeing abenefit from low commodity prices, now is a great time to put that[hedge] on.”

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Susan Kelly

Susan Kelly is a business journalist who has written for Treasury & Risk, FierceCFO, Global Finance, Financial Week, Bridge News and The Bond Buyer.