Insight from our experts

FX Solutions for Corporate Treasurers.

Alvin Lee, Director FX & FX Derivatives, Barclays Commercial Bank discusses the risk management strategies that every Corporate Treasurer should be considering in this market.

Alvin Lee
Quick Facts Name: Alvin Lee
Company: Barclays Commercial Bank
Position: Director FX & FX Derivatives

Thoughts on the Current Market

The theme of today's foreign exchange markets is volatility, one which looks set to continue for some time to come. Continuing problems in the credit world, a reversal in the fortunes of commodity markets and varying degrees of economic weakness in the G7 economies have led to fluctuating foreign exchange sentiment in recent times.

Businesses will find that their risk management strategies are tested in these challenging times. The volatility in the GBP/EUR rate is a case to point. Relative market stability for much of 2008 meant clients became used to rates between 1.24 and 1.30. The recent move at the end of December to as low as 1.02 meant many UK-based importers have seen a 20% increase in costs in just over two months. This has seen itself felt in a number of ways – firstly, market stability earlier in 2008 lulled clients into forsaking risk management strategies, hence they were underhedged in the recent weakness. Secondly, FX market volatility is now at extreme levels, leaving many Corporate Treasurers uncertain as to whether they want to enter into hedges at the current levels – simultaneously fearful of further weakness but hopeful of a reversal in the trend.

Those businesses that have adopted a constant risk management policy across the entire timeframe have found that this has worked in their favour as conditions have changed and markets have become more volatile. However, even companies that have been hedging their FX risk should continually revisit the process to ensure it remains appropriate for their ongoing needs.

Back to top FX Risk Management – Protecting the Business

This current volatility brings our focus back to the key requirement of foreign exchange risk management – namely to protect profitability. With the continuing globalisation of business, we are finding that FX risk management is now one of the key issues our corporate treasury clients are focussing on.

In its simplest form, the objective of FX risk management is to ensure business survival through the management of international payables and receivables. Businesses should not be caught up in assessing whether their hedging has been profitable or not, rather, the aim should be for a satisfactory rate on a business's FX flows. As a secondary consideration, effective FX hedging may assist a company in gaining a competitive advantage.

For many clients, the market volatility places an even greater focus on 2009 budget rates. Budget rate setting techniques include averaging several bank forecasts, the current 12 month forward rate and even using the spot rate. Each technique has its pros and cons but using the forward rate is the one most likely to reflect a rate that is achievable for a treasury without needing to take a speculative view. The main downside is that depending on which side of the forward points you are, the all-in forward rate may make the transaction appear less attractive than the "do-nothing" approach i.e. retaining spot exposure despite the potential losses this may incur.

Once the budget has been set, a business needs to consider its risk management strategy. There are a range of solutions available to Corporate Treasurers to help them with this process.

Back to top Solutions – Products and Advisory Services

There are three basic instruments Corporate Treasurers can use to manage their FX risk – spot deals, forward exchange contracts and structured products which typically involve a combination of a forward contract and some type of FX option. These structures allow clients to both protect a worst-case outcome whilst at the same time allowing them to participate in favourable rate movements to some degree. An example would be an importer client seeking protection against GBP/USD depreciation but also wanting to have some participation in any rate appreciation. A thorough understanding of the client's objectives and risk tolerance is a must to ensure that the solutions offered fit the client's needs.

Back to top Accounting Challenges – IAS 39

One challenge facing businesses in the middle of their budget planning is the impact of hedge accounting. Understanding the implications of hedging on P&L and equity calculations is necessary to ensure the objectives of the hedge are met. With many businesses using cash flow hedging for the treatment of forecasted foreign currency purchases, appropriate product selection will ensure the hedge matches the forecasted transaction (minimise earnings volatility), while achieving a suitable rate under the circumstances. If not the business faces two issues – the hedge may not protect them economically; and also that it fails to meet the effectiveness criteria and hence translates into earnings volatility.

Back to top Live Pricing and Online Dealing

One of the key offerings that a relationship bank should provide is a capable online dealing platform. For our commercial clients we offer one such solution in BARX Commercial – providing live pricing in a wide range of dealing currencies as well as excellent money market capabilities to allow multicurrency deposits. For clients seeking up-to-the minute information, other useful resources include economic research, regular market updates and FX charting capabilities.

Back to top Conclusion

While there is a lot for Treasurers with international business exposures to think about in today's markets; the costs of not doing so are significant. The level of economic uncertainty means that the current market volatility is here to stay for the time being at least; proactively hedging against the risks resulting from this volatility is the most effective defence. Barclays Commercial Bank is well placed to help businesses succeed in these challenging times.

Back to top In a nutshell
  • With continued globalisation of business and increased market volatility, FX risk management is one of the key issues Corporate Treasuries are focussing on.
  • Proactively hedging against these risks is the most effective defence.
  • FX risk policies should be revisited periodically to ensure it remains appropriate for your ongoing needs.
Back to top Where to go for more information

If you would like to discuss any of these topics further, please contact your local Barclays Commercial Bank Relationship Team or visit www.barclayscommercial.com.

Back to top