After the announcement that the United Kingdom had voted to leave the European Union, market chaos arrived swiftly. In two days, the British pound fell 12 percent against the U.S. dollar, to its lowest level in more than 30 years. The consequences of this move were clear: Brexit will slow the European economy, and its effects will ripple around the world.
This currency crisis, like others that have come before it, involves more than a single currency. Thus far, we have seen ripple effects from Brexit in the pound, euro, Mexican peso, Swiss franc, and yuan, to name a few. Global corporations are asking not only "How low will the pound go?" but, more importantly, "How will Brexit impact the corporation across all of its currency pairs [which may number in the hundreds]?"
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What Is a Treasurer to Do?
Corporate treasurers and CFOs must understand, be able to communicate, and manage the impact of Brexit on the business. Many boards have already called meetings to ask CFOs the six questions below. Analysts will absolutely be asking similar and much more clinical questions during Q2 earnings calls. CFOs should be prepared to answer them.
1. What are our current exposures across all currencies? The treasurer and CFO need to know where the exposures are on the balance sheet and where the cash flows are at risk (e.g., revenue, expenses, cost of goods sold) across all of the currency pairs in which the company does business.
2. What is the risk associated with those exposures? The treasurer and CFO should be able to identify how much negative impact those exposures to amount to, especially at current exchange rates. The risk posed by currency exposure is best expressed as EPS-at-Risk. A variation of Value at Risk (VaR), EPS-at-Risk puts the risk in context of earnings per share, which is where currency impact ultimately ends up.
3. What will the impact of these recent moves be on a go-forward basis? What happens if CNY, GBP, and EUR all move further? To answer these questions, right now, many organizations are currently running what-if scenarios to see how the organization would be affected under certain exchange rate scenarios, which could account for further depreciation in currencies such as the pound. They use scenario analysis to stress test their currency risk management programs.
4. What was our hedge coverage prior to Brexit? Were our hedges effective? Currency-aware organizations may or may not externally hedge their exposures, but they always know the extent to which they are hedged on any given exposure, and they know the effectiveness of those hedges. This is one of the most critical questions to be able to answer rapidly in the midst of a fast-moving crisis.
5. What natural hedging abilities do we have? After (and during) crises such as Brexit, the costs of financial instruments used to hedge currency risk may rise sharply. This makes it exceptionally important to be equipped to quickly identify opportunities to eliminate exposure by creating natural offsets internally, moving operations, etc.
6. What are our current impacts (negative or positive) as a result of the Brexit-driven moves? Global organizations are digging into the impact of Brexit on the balance sheet—in terms of FX gain/loss on monetary assets and liabilities—and income statement, in terms of FX gain/loss to revenue, expenses, and cost of goods sold.
A currency-aware organization can fully answer all six questions within an hour. Those that were able to do so during the early hours of Brexit fared very well.
Steps to Prepare for the Next Domino to Fall
Becoming equipped to answer those questions means your organization is currency-aware. The first step is being able to reach into your systems of record and pull out currency exposure data. The vast majority of currency-aware organizations leverage analytics tools to extract and standardize their exposure data. No matter how many disparate systems the organization has, the company has visibility into exposures at the push of a button, and confidence that the data is accurate and complete.
Many currency-aware organizations also leverage automation to institutionalize the process of currency risk management. Automation enables the organization to manage currency risk at scale, quickly and affordably.
The next currency crisis is coming. It's not a question of where; it's a matter of when. Finance executives who can answer these six questions within a matter of minutes after the next crisis will position their organization to feel minimal impact from the currency event, and will position themselves for success.
Wolfgang Koester is the CEO and co-founder of FiREapps, a provider of cloud-based currency analytics for corporate finance.
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