While most mid-size companies recognize currency fluctuations as a significant business risk, many don’t have the resources in-house to manage that FX risk effectively.
That’s one of the main findings of Nordea’s new Hedging Strategies 2019 report, which for the first time focuses its lens on the medium-sized corporate segment.
“No matter how big the risk is for the company or how much it’s going to affect their bottom line, FX hedging is usually just one of many tasks given to the finance manager or CFO at these companies,” says Nordea Markets’ Tuomo Jääskeläinen, chief sales manager for FX Sales & Distribution in Finland who worked on the survey. “They don’t really have the resources to adequately tackle the task,” he adds.
Nordea surveyed over 100 mid-sized corporates across all four Nordic countries in over 10 industries, asking them about their strategies and policies around FX risk handling. The survey’s focus on the mid-size segment was a novel one, says Jääskeläinen, noting that in his 10 years of working with medium sized companies, he has never seen any hedging surveys done for them.
Past surveys have typically focused on the hedging practices of the big multinationals, aiming to set a benchmark for FX risk management. However, smaller companies have found it difficult to relate to those benchmarks, without the resources to execute their hedging in the same way.
With the latest survey, the mid-size companies are getting a turn in the limelight. It turns out most of them, nine out of 10, do in fact hedge. Where they fall short, compared to their larger counterparts, is how systematically.
It pays to be systematic
Only 53 percent of survey respondents have a systematic approach to hedging, even though FX is the number one risk management concern for companies trading with foreign currencies. That’s compared to 84 percent of large corporates that hedged systematically in Nordea’s 2016 survey.
“The most important thing for companies when talking about hedging is that they do it systematically,” says Jääskeläinen.
If a company has a constant flow of income in dollars, for example, they may wait to hedge, hoping for a better rate next week or month, he explains. But exchange rates move so quickly, the opportunity can quickly evaporate, leaving one with even worse rates. Having a systematic approach eliminates the question of whether it’s a good or a bad time, spreading out the timing risk.
“Companies should think about it like insurance. Hedging is a way of insuring your business,” says Jääskeläinen.
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“Outsource your hedging to us”
So how to achieve the best hedging practices without the budget of a multinational corporate? That’s where Nordea can step in.
“Companies can outsource their FX hedging to us,” Jääskeläinen says, adding, “We as a bank have a lot of resources around FX hedging and can really help them on that matter.”
Nordea offers the full package of risk management services, from calculating how much currency fluctuations affect a company’s financial figures all the way to developing a hedging model and executing the hedges.
Jääskeläinen and his colleagues can perform a structured analysis of the FX risks and effects on a company’s EBITDA, a presentation the client can then take to the board. That typically bumps up the priority of getting a formal, documented policy for FX risk management in place, Jääskeläinen says. The survey found that 63 percent of companies have a documented hedging policy, while 89 percent who don’t say it’s too difficult to define or they don’t prioritise it.
Nordea can help draft a company’s FX risk policy and work with the client to develop a systematic hedging model, such as a layered or rolling strategy. And when it comes to executing the hedges based on the chosen model, Nordea has automated solutions that eliminate the need for manual work.
So even without the budget of a large treasury operation, by tapping into Nordea’s large pool of resources, smaller companies can also implement best practices when it comes to financial risk management.
Fact box: FX hedging explained
FX volatility can have a serious effect on cash flows, margins and values of foreign assets if left unhedged.
An FX risk arises if the exchange rate of a future foreign exchange transaction is not known for certain. Exchange rates can fluctuate dramatically and are often difficult to forecast. Much can happen between the time your company closes a deal with a foreign partner and the time the payment hits your account. Hedging allows you to mitigate those FX risks, making your business more predictable and reducing the fluctuations in cash flows and profits.
Nordea offers many hedging products that allow you to manage your company’s FX risks. These include:
- FX forwards: A binding agreement between a company and Nordea for buying or selling a certain amount of currency on a certain maturity date at an agreed exchange rate. This lowers the company’s FX risk and helps in budgeting, managing cash flows and setting prices. The company will know the precise future exchange rate, which means the expenses from purchased products (or income from sold ones) are also known in advance.
- An FX forward can be extended or executed earlier with an FX swap.
- Time-option forward: A binding agreement between a company and Nordea for buying or selling a certain amount of currency on a certain maturity date at an agreed exchange rate. Unlike an ordinary FX forward, the time-option forward can also be executed in parts and at any time before maturity, but not later than the maturity date. The future exchange rate is known, and the precise payment schedules do not have to be known in advance.
- Option hedges: An FX option gives you the right (without the obligation) to buy or sell foreign currency at a future date at an agreed-upon rate. The customer pays a premium for an option hedge. Hedges can also be executed using zero-cost option strategies, in which case no separate premium is paid. Option hedges can vary considerably and are tailored to our customer’s needs every time. They can, for example, allow you to benefit from a positive change in an exchange rate, access to a more favourable exchange rate than the market rate, or simply a limited hedge against FX risks.
The best solution for hedging FX risk is to hedge it systematically, based on our experience and the majority of those surveyed. Those systematic strategies include:
- Layered hedging: using several hedging products with different start and maturity dates to cover a company’s future exposure. The survey found that 27 percent of companies use layered hedging where the degree of the hedge rate is reduced to the end of the hedging period.
- Rolling hedging: obtaining new options and futures contracts with new maturity dates to replace expired positions. The survey found that 24 percent of companies use rolling hedging where the maturity of the hedge and the hedge ratio are kept constant.
Don’t miss this 5-step guide to managing your currency risk.
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