As currency volatility has spiked in recent months, we’ve also seen a spike in the impact that currency swings are having on corporate earnings. In the “2016 Global Foreign Exchange Survey,” which Deloitte released in March, the firm predicts that levels of uncertainty in foreign exchange (FX) will remain high throughout this year.

The survey asked corporate treasurers and treasury professionals around the world, in organizations with US$1 billion or more in annual revenue, about how they’re managing currency risk. It identified some critical areas for improvement in corporate FX risk management practices in preparation for the ongoing volatility.

Treasury & Risk sat down with Niklas Bergentoft, director of global treasury advisory services at Deloitte & Touche LLP, and Richard Brooks, specialist leader in the global treasury advisory services group, to discuss the survey results, as well as what companies should be doing to improve their treasury function’s ability to manage currency risk more effectively.


T&R:  What are some of the key take-aways from Deloitte’s “2016 Global Foreign Exchange Survey”?

Niklas Bergentoft:  The survey is telling us that there are clearly some challenges around how companies manage FX risk, and that there is a disconnect between how treasury functions manage currency risk and what their boards are expecting.

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


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

"Boards should be challenging their treasury teams more. And treasury has an excellent opportunity here. Now is a good time for treasurers to make a case for the value of transforming the way the organization manages FX risk." --Niklas Bergentoft, DeloitteNB:  Yes. In our global treasury survey a year and a half ago, we found that 50 percent of companies had challenges with visibility into their FX exposures. This year, we’re seeing that 56 percent can’t clearly and reliably see their exposures. And that explains why so many U.S.-based corporations are taking big hits on their earnings due to currency impacts. It’s pretty simple to see what’s going on: If companies can’t clearly see it, they can’t manage it.

It’s also pretty clear where exposures are originating in the company—it tends to be at the front lines of the business. FX risks are cropping up whenever the sales force structures a sales deal that has a currency component. They’re arising when the procurement function is acquiring materials in a foreign currency. And the information that treasury is receiving from these other functions is not enabling them to accurately estimate the size and timing of company’s FX risks.

When the treasury department doesn’t understand how and when the business is generating foreign exchange exposures, that really impacts their ability to effectively manage the impact of those exposures on margins, and hence on the results.


T&R:  Figure 1 also shows that 33 percent of treasury functions have trouble understanding the business. What should the corporate treasurer in these companies be doing differently?

NB:  The way you go about addressing that is looking at how you manage FX risk, and transforming the operating model so you get treasury more embedded with the whole supply chain. By doing a better job of partnering with the business, treasury is going to get better visibility and understand the company’s FX exposures better. By educating and holding the front line of the business accountable for their actions and their currency impacts to the bottom line, treasury can drive improved accuracy in the exposure forecast.

Figure 1: Challenges Treasurers Face in Managing FX Risk

Richard Brooks:  The other aspect to this is that treasury needs to do a better job of managing the commercial effectiveness of currency hedging programs. They need to measure the effectiveness of the exposure data that the business units are providing, by comparing forecasts to actuals in order to understand volumetric risk in the forecasts. And the businesses need to be accountable for forecast error.


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

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

RB:  And it’s worth noting that if you do the forecast-to-actual comparison around the effectiveness of your hedging programs, that will improve the business’s understanding of FX and how currency issues impact their business. It will give them incentive 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 share that information with the business? Or are there other things treasury should do to improve forecast accuracy?

RB:  Well, treasury certainly needs to have a dialogue with the business around understanding the forecasts and exposures, and making sure there aren’t any risks that aren’t captured in the exposure data they receive. Part of that conversation needs to be validating the results and where the forecast errors are. So information needs to be provided to the businesses, but there needs to be dialogue around that to keep improvements in forecast accuracy moving forward.

NB:  The treasurers of organizations are only as effective as the information they have and the role they’re taking throughout the organization. And boards can take a more active role in setting that expectation. The treasurer’s role should be to drive visibility into the exposures and forecasts, and to do that, they need to understand the business.

In fact, we think boards should be challenging their treasury teams more. And treasury has an excellent opportunity here. 2015 was a very tough market, especially for U.S.-based corporations, in terms of currency impact. This year, currency markets continue to be challenging. So there’s an opportunity for treasury departments to 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 strategic role, they should also be properly investing in the tools that treasury needs to do a better job of analyzing FX exposures companywide. Treasury departments have been under-invested in for way too long. It’s not fair to expect treasury departments to manage FX risk effectively without the right investment in the function. Now is a good time for treasurers to make a case for the value of transforming the way the organization manages FX risk.


T&R:  And this investment is mostly in treasury technologies?

Figure 2: Key Risk Management Dashboard Reports for Board of Directors, Risk Committee, and/or Senior ManagementNB:  Technology is not the entire answer, but it’s important. Our survey also found that, among the companies that can actually see their FX exposures, half gather the data manually. The information-gathering is slow, which means treasury doesn’t have the information right away, which in turn reduces hedging effectiveness. By getting the right investment in technology, treasury departments can provide more robust reporting and constantly look for opportunities to create value.

At the same time, treasurers need to start speaking the same language as the board, and really look at FX from more of a commercially effective perspective, in light of continued business growth and profitability.

Treasury departments need to take this opportunity to demand the right investment in their function, in their capabilities, in their people, in their tools, and in their technologies. Because it’s a pretty clear-cut business case these days.


T&R:  What information should treasury be reporting to the board about FX risk, and how often?

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

RB:  Figure 2 is very interesting in terms of the level of information corporate boards are currently getting around foreign currency exposures; the information is very basic. It’s mostly an exposure summary, FX gains and losses, and coverage ratios. Those reports don’t provide sufficient detail for the board to see where FX is really impacting the business—top line, bottom line, 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 the appropriate benchmark for measuring the commercial effectiveness of your hedging programs, and that includes linking the results of the program to your profit margins or an earnings per share metric, or other financial measure that the business will understand in terms of impact of FX volatility on the financial results.

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


T&R:  Is it also important to provide the board with results of stress testing and scenario planning analyses?

RB:  Yes, those are important as well. A lot of the stress tests you typically see being done and reported on answer pretty basic questions like ‘If foreign currency markets move up or down 10 percent against the dollar, what does that equate to in terms of percentage impact to the business or to profits overall?’

Treasury functions could do more to provide additional granularity around scenarios where some currencies may be moving in a favorable direction, while others are moving in an unfavorable direction, and looking at the impact of those currency moves on consolidated earnings and cash flows.

NB:  Almost two-thirds of our survey respondents think they’re doing a pretty good job of reporting to the board on currency risks. But overall the reporting that’s being done is fairly basic. The least-popular activities on Figure 2—stress testing and scenario analysis, and benchmarking impacts to metrics like earnings per share and gross margin—are the approaches that take a more forward-looking view on the exposures. Reporting that to senior management would be more impactful than some of the activities that a larger proportion of treasury teams are currently engaging in.


T&R:  Why is the typical treasury function not providing the board with this type of information?

RB:  Well, treasuries are not receiving the quality and granularity of data that they would need to improve reporting around FX. And I think for many companies, the reason why treasury hasn’t historically received the FX information it should is that up until about two years ago, the dollar was depreciating against major currencies, which meant there was always a benefit as foreign earnings were translated back into U.S. dollar equivalents. So even when there was volatility and noise in currency impacts on companies’ bottom line, it was beneficial volatility and noise, as opposed to the current environment where it’s detrimental. So that took some pressure off treasuries.

"The treasury team needs to make sure they're looking at currency risk from the perspective of how FX will impact gross margin. When treasury is looking at FX risk in this way, the conversation with the board will be better aligned." --Niklas Bergentoft, DeloitteNow that we’re in a more volatile world and the dollar’s strengthening, I think we’re going to see more boards asking their treasurers to improve the analytic explanation around how FX impacts financials.

NB:  And if they aren’t doing that, they should be.


T&R:  What steps should treasurers take to determine the right level of reporting of FX risk to their board?

NB:  The treasury team just needs to make sure they’re looking at currency risk from the perspective of how FX will impact gross margin. They need to look at other profitability measures too, and to look at smoothing year on year. If they do that and have the right KPIs in place, that approach will drive to a view of the currency impact on earnings per share.

When treasury is looking at FX risk in this way, the conversation with the board and senior managers will be better aligned. And frankly, it’ll also be more aligned with how the investor community and analysts are looking at FX risk when they look at the value of the company.


T&R:  Your survey also found that 28 percent of companies use two sources to quantify FX exposures, and 31 percent use three or more sources. What is the best practice in terms of gathering this information?

RB:  This is one of the key challenges around visibility to FX risks—manual exposure-capture processes. When global companies are on multiple ERP systems, they have multiple sources of FX information that needs to be provided to treasury. The more complicated a company’s treasury systems infrastructure, the more likely it is that treasury will be reliant on 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 FX information was a big challenge. As you mentioned, in this year’s survey, 59 percent of respondents said their company uses two or more sources of information. That certainly makes it more difficult to collate all the FX exposures.

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


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

RB:  Yes, definitely. Most treasury functions have an opportunity to do a better job of finding natural offsets of exposures. Only 46 percent of survey respondents are currently using those natural hedges across entities, or through netting of exposures.

This is especially important in emerging markets. As Figure 1 indicates, volatility in restricted-currency markets has really moved up the list in terms of being a top concern for treasurers. A lot of companies have become more international. More than half of our survey respondents do business in 20 or more countries. And a lot of revenue growth for multinationals is in emerging-market countries. Most treasuries are using derivatives to manage their exposures. But in emerging markets, it’s not always as cost-effective—or necessarily even possible—to use derivatives to manage your risks. So alternatives such as natural management techniques may be a solution in these markets.

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


T&R:  Are these conversations that many corporate treasurers are currently having with their boards and senior management?

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