Treasury & Risk:  You said that you are seeing companies respond to the current market dynamics in two ways. The first is to attempt to reduce the number of hedging trades they're completing. What's the other?

Andy Gage:  Anytime we see strong directional moves in currencies, those shifts uncover inefficiencies in how companies account for FX in their business and how they define exposures based on that. And that is something I'm seeing happen quite frequently right now. A lot of corporate treasury teams are realizing they don't have good visibility to what the company's true exposures are.

Inefficiencies in the multicurrency accounting process that had below-the-radar impacts a year ago are now showing up due to the sharp moves in currencies, and they are causing a lot of heartburn. So some companies are taking a step back and saying, 'We need to not only clean up our hedging program, but also do a better job of accounting for currencies so that we don't create self-inflicted wounds.'

T&R:  What's an example of that type of self-inflicted wound?

AG:  One example that is fairly common is what we call a 'phantom exposure.' This happens when, for instance, people book the balance on a cash account in a different currency. Let's say a euro-functional entity books its bank account balance in sterling. The treasury team may decide to come in and relieve that sterling bank account balance but only relieve the local-currency part of the balance. If they mistakenly fail to relieve the underlying transaction currency balance, the sterling balance will still show up in their ERP system at a very low level. If an accountant in Belgium subsequently logs onto the ERP system and looks at the euro-currency balance, they will see it as zero. And on their terms, it will be zero, but the company will still have the sterling balance in the bank account, which the Belgium accountant will not see. Because those types of things are being remeasured, that will throw off the company's FX gain/loss reporting. I've seen that happen a lot of times.

Another area where we commonly see improper accounting is intercompany transactions. As the payables and receivables move through the internal supply chain, they may not reconcile on reporting transactions in a local-currency balance. If that gets out of whack, the treasury group may not have visibility into the problem.

T&R:  How can a treasury group root out these types of issues?

AG:  It can be really difficult without good analytics and good intelligence around data integrity. When you have the right technology, you can identify these problems and develop the information that both treasury and accounting need to reduce the company's currency exposures. But a lot of companies are discovering in the current environment that their business intelligence is lacking in this area.

I just had a call with a client that thought their hedging program was pretty good a year ago. Now they're seeing all kinds of issues cropping up with the large directional currency moves, and they're very focused on eradicating those accounting mishaps.

T&R:  Where do you think currency risk management is headed?

AG:  I think we're going to see more of the same for the foreseeable future. The U.S. dollar is not showing any signs of relenting its dominant position. There was a meeting of the G-7 to try to figure out how to deal with the juggernaut of the U.S. dollar, and they came to no conclusion. Unfortunately for the companies that operate in these economies, there are structural issues that are very difficult to fix quickly.

Central banks are reacting differently to inflation, so they are not acting in tandem. And then there's a lot of uncertainty over what's happening in Europe and in the Ukraine. We still have ongoing issues with the supply chain and the potential for a recession. And yet, despite all that, the U.S. still has the most robust and resilient economy in the world—and I don't think that's going to change anytime soon, even if the Fed pushes the economy into recession with its aggressive interest rate moves to stem inflation.

All that is to say: I think the challenges of currency volatility, the strong dollar, and rising hedging costs are going to continue well into 2023, although countries' fortunes may shift relative to one another. I think about currency issues as akin to the big red storm cloud on Jupiter. It's always moving, and right now, that storm cloud is sitting squarely over North America. If the dollar starts to lose some of its dominance over the euro and sterling, and those economies start to recover, then the storm cloud might move over to Europe, and European companies will face a lot of the headaches we're currently facing. A lot of European companies have more currency exposure than the typical North American company, so things could get bad in Europe in the second half of next year.

T&R:  You mentioned the Russian war in Ukraine; I noticed in the October 2022 'Currency Impact Report' results that the Russian ruble was the currency most frequently mentioned on North American businesses' earnings calls. Is there any relief in sight for U.S.-based companies that have significant exposure to the ruble?

AG:  Not really. From a market-direction standpoint, we just saw another huge spike in the past couple of months. When Kyriba releases our next 'Currency Impact Report,' with Q3 results, I expect to see even more market volatility on top of the strong dollar. We're still thinking the worst is yet to come for the ruble.

T&R:  So you would advise treasury teams to take a hard look at how their current hedging program is working, and whether it will continue to work if the markets follow the same trends into 2023?

AG:  Yes. And to really deal with this, they have to make sure they have real-time information and they understand what's happening in the marketplace. A lot of the risk management programs that are in use today were designed in a zero- or low-interest-rate environment. For example, one company I talked to recently had a policy of hedging 100 percent of the exposures that they see. The goal of the financial risk managers was to completely drive volatility out of their P&L. Now, with the surging interest rates on top of the high volatility, they can't afford to keep doing that. So they are stepping back and completely reassessing their risk program.

Hopefully CFOs and treasurers are bringing their 'A game' to dealing with the current state of FX risk management. It is a very significant issue. It is costing companies a lot of money, and it is causing a lot of distractions. This is a great opportunity for treasurers to stand out and be the star professionals they're capable of being.

See also:

• FX Crisis Management: Dealing with Currency Shocks