As foreign exchange (FX) volatility intensifies amid deteriorating global economic conditions, a burly U.S. dollar, and rising interest rates, boards and executive teams are becoming more interested in the financial risk management activities that treasury teams use to manage FX risks and other exposures.
This attention is motivating treasury groups to quickly root out the most easily resolved sources of inefficiency in their hedging programs. That said, some efficiency improvements are easier—and, well, more efficient—to complete than others.
Treasury leaders and financial risk management experts describe the following sources of inefficiencies as ripe for quick fixes:
1. Operational shortcomings. Hedging programs may develop operational inefficiencies over time as they grow and adapt to changing company needs and priorities, as well as to new business models. The primary causes of these issues include unclear program objectives, limited internal communications, and a lack of supporting automation, notes Chatham Financial COO Amanda Breslin.
Although centralized and decentralized hedging programs both have merits, each structure has unique soft spots that the treasury team should tend to. “Decentralized hedging activities with limited coordination can often lead to programs with a high volume of trades that may not capture netting across the organization or optimize staffing needs,” Breslin explains. “Likewise, some policy-level decisions around hedging thresholds, execution frequency, and counterparty diversification may not scale with company growth and may need to be revisited to ensure hedging costs are providing the greatest impact.”
Operational efficiency gains start with getting the treasury team and lines of business aligned on the impacts of financial risks and methods of managing them. Erik Smolders, a Deloitte Risk & Financial Advisory managing director in treasury management, encourages treasury leaders to ensure that their internal business partners understand how currency movements can affect procurement and sales processes—for example, when sales agreements have currency-driven pricing triggers or caps. Better-informed lines of business can then keep the treasury group informed whenever a currency impact arises.
“Stakeholders across the organization need to be aligned in understanding the objectives of the company,” Breslin says. “A regular cadence across stakeholders is important to keep strategic objectives aligned while reviewing tactical program changes.”
2. Too much trading. Treasury groups often conduct spot trading when focusing on balance sheet risk. In many cases, however, too much and/or unnecessary spot trading takes place, notes Atlas Risk Advisory CFO Scott Bilter. He adds that inaccurate forecasts often contribute to excess trading.
Dmitry Martynov, senior director of cash management at eBay, agrees. “A lot of the [inefficiencies] relate to how the trading mechanism is structured,” he says. “There is definitely plenty of room for optimization.”
With a balance sheet hedging program, the treasury group can choose how frequently they settle their trades, so long as they appropriately manage the hedge’s mark-to-market gains or losses. “Settling your trades every month can become a tough exercise for your cash management team to perform,” Martynov says. “Each company needs to find its sweet spot, which could be once a year, twice a year, or more frequently. If you’re settling too often, you might want to consider trading less frequently. If you’re not comfortable with the exposure, increase the frequency.”
3. Inaccurate and/or incomplete data. “The main driver of inefficiencies in hedging programs is inaccurate data,” Smolders asserts. Some data problems relate to how currency exposures are reported from an enterprise resource planning (ERP) system. Late bookings of invoices or accruals, and inconsistent reporting or booking of assets and/or liabilities denominated in foreign currencies, can trigger these shortcomings.
Configuring ERP systems to identify monetary assets and liabilities can help improve hedging program efficiency, when used in conjunction with a treasury management system that captures exposures from the ERP system to build foreign-currency–denominated cash flow forecasts, Smolders notes. Treasury teams can also use dedicated cash flow forecasting tools to forecast exposures by currencies. Martynov emphasizes that using centralized trading platforms can generate major efficiency gains.
Making these and related improvements to hedging activities can serve a dual purpose. In addition to saving time and money, these improvements can help treasury leaders make a compelling case to fund larger financial risk management process and systems improvements.
- October 2022 Special Report
- To Hedge or Not to Hedge?
- Getting Back to Natural Hedges
- Beautifying the Business Case for Hedging Programs
Eric Krell’s work has appeared previously in Treasury & Risk, as well as Consulting Magazine. He is based in Austin, Texas.