Counterparty and bank risk emerged on treasurers’ radar after the 2008 crash, but foreign exchange, credit, liquidity and other types of risk are ever-present, says Neill Penney, Head of FX Workflow at Thomson Reuters. The on-going Greek eurozone crisis and Swiss de-pegging against the euro earlier this year just reinforce the need for FX hedging, supply chain resiliency and prudent planning.
No corporate treasurer will have missed the events of January 15th earlier this year, as the Swiss National Bank (SNB) unexpectedly de-pegged the Swiss Franc (CHF) versus the euro unleashing massive volatility. The 3-year policy of supporting a currency floor of CHF1.2000 to the euro was abandoned on 15th January 2015, quickly leading to a new floor of 0.8500 before the market recovered and near-parity was established. This had ramifications for all euro currency pairs and many treasury departments operating in the eurozone.
Fast forward to the events of the summer with the debt debacle in Greece and bailout reforms talks still in play, heightened volatility continues to influence the Euro’s value and set the pace for currency markets.
Treasurers need to hedge against these currency fluctuations but it is getting harder to do as market volatility increases. This hasn’t historically been the case since the launch of the European single currency but with US and UK interest rates set to rise over coming years and the on-going Greek economic crisis dragging down the value of a euro, foreign exchange (FX) pairs are in a state of flux.
Volatility is more and more common since the 2008 financial crash with global political, regulatory, and economic uncertainty a new fact of life which treasurers need to be prepared for. Revenue from export markets and costs from foreign suppliers need to be FX hedged by treasuries with Forwards and Options if firms are to benefit from operating in a globalised marketplace.
The Bank of Japan (BoJ) unleashed its own wave of FX volatility when it expanded its quantitative easing (QE) programme on 31 October 2014, moving the dollar and Yen (JPY) currency pair and precipitating hundreds of billions of dollars’ worth of trading on large professional FX trading platforms such as Reuters Matching.
You need to design a proactive, forward-looking hedging strategy, supported by appropriate technology, data and analytical tools that provide accurate and timely information to effectively reduce risk. Thomson Reuters can help in this regard, providing news feeds, information, alerts and modelling tools, allied to capital markets connectivity and execution platforms which can action treasury strategies.
Wider Treasury Risks: Capital Controls
It’s not just FX volatility that matters. Treasurers need to be alert to other new types of risk as well. For instance, the capital controls imposed in Greece – and only just removed in Cyprus after two years – mean that transfers abroad are banned, cash withdrawals are limited, cheques cannot be processed and so forth. All of which has the potential to adversely impact physical and financial supply chains.
As many Greek businesses rely on imports from abroad, the current banking limits mean that such supply chains are cut off. And if a company cannot order and pay for a part from abroad that is needed to manufacture its product the knock on effect could be extreme. Equally, global firms with operations in Greece need to be able to pay workers and supply chain partners and to move cash around subsidiaries as required. Capital controls make this difficult.
I know of some treasurers that stockpiled dollars just in case a return to the old Drachma currency became necessary in Greece, giving them a universal global reserve currency for the transition in case it was needed. Perhaps other treasurers have considered using the Bitcoin (BTC) crypto-currency to get around currency controls and pay suppliers abroad instead? Would they accept BTC? I do not know but these are the types of risk management options and strategies that treasurers are increasingly expected to be able to present to Boardrooms for their consideration.
Treasuries need to explore such alternatives or, even better, be able to foresee the dangers and manage their price, supply and supplier risks to continue in business regardless of uncertainty.
Supply Chain Risk
Some treasurers these days, in Greece and elsewhere, are even looking at supply chain risk. Where they identify a single vital supplier that is the only one supplying their company with a necessary part they seek to mitigate this risk by diversifying production to a second supplier elsewhere. The firm is then protected if the previously standalone supplier goes bust or, god forbid, is placed out of action by a natural disaster.
Mustafa Kilic, the then head of regional European treasury and group risk at Indesit, designed just such a business continuity risk assessment programme at the turn of the decade. The aim of the on-going annual effort was to cope with the counterparty and bank risk emanating from the 2008 crash.
Indesit’s wide-ranging risk mitigation strategy covered everything from FX to liquidity and working capital management, but was particularly focused on unexpected risks. For instance, Kilic identified a sole Asian supplier of a single refrigerated cooling part as an unacceptable supply chain risk. Action was taken to mitigate this risk by diversifying production to a second Latin American-based supplier, just before a devastating earthquake hit Japan in 2011 temporarily knocking out the original supplier. Good planning averted disaster before it happened.
It’s not cash management, but it is an example of how treasurers are nowadays expected to be risk-averse and able to mitigate threats to the company from whatever source.
Risk management is almost as important a duty for the modern treasurer as everyday cash management, especially as automated payment and billing systems free up treasury time enabling practitioners to do more value-adding work.
Foreign Exchange Hedging
As businesses target greater efficiency and increased visibility, corporate treasurers are relying on technology to access essential data from which they can make more informed decisions about their FX hedging.
Desktop and mobile solutions can be deployed with tools that provide easy access to trusted news, data and analytics, all filtered by relevance to a user’s specific needs and displayed in a visual manner that’s easy to understand and act upon. As an example, corporate treasurers may look to solutions that provide a better understanding of the rates available for hedging their FX exposures across different time horizons on a mobile phone or tablet, when they are out of the office.
Thomson Reuters treasury workflow solutions can accommodate mobility and incorporate a treasurer’s own choice of treasury management system (TMS) into an integrated technology ecosystem. Common standards, connectivity and open technology platforms can deliver a flexible service orientated architecture (SOA) to meet users’ needs – all under Thomson Reuters umbrella.
A corporate treasurer studying the FX forward curve, for instance, may decide that certain maturities look particularly cheap or expensive, depending on their own view of the currency risk. At Thomson Reuters we have designed our trading tools to let corporate treasurers progress from indicative market prices to viewing tradable prices from their FX brokers. These prices will depend on a company’s credit rating, the size to be transacted and the broker’s appetite for that currency at that time. Built-in trading tools let the treasurer move seamlessly from comparing prices to trading with the broker of their choice, and finally to automatically booking the trade in their TMS.
Thomson Reuters’ treasury workflow solutions can also capture prices from other brokers, as well as the original indicative price, so the treasurer can subsequently prove ‘best execution’ in-line with their trading policies and regulatory requirements.
An integrated solution enables fast, effective FX and other risk strategies to be implemented quickly in an increasingly volatile world where treasuries must be on guard against risks to the future of the company.
Designing a hedging strategy is best done by experimenting with different ‘what-if’ scenarios. It involves finding a balance between the different market risks a treasurer is worried about and the cost of neutralising those risks. With accurate information and the correct modelling tools from Thomson Reuters treasurers can work out their plan and use our trading platforms to execute and book trades. Our mission is to be trusted for the decisions that matter most, and to empower professionals to act with confidence in a complex world.
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By Neill Penney, Workflow Management Proposition Manager, Thomson Reuters