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Currency volatility is forcing companies to ramp up their FX hedging strategies

Currency volatility is forcing companies to ramp up their FX hedging strategies

By Eric Huttman, CEO at FX-as-a-Service provider, MillTechFX

Currency volatility has become one of the dominant macroeconomic trends of the year. The dollar has surged to 20 years highs, while the pound and euro have slumped to 50 and 20-year lows respectively.

This is having a serious impact on corporate earnings. According to Kyriba’s October Currency Impact Report, global companies sustained over US$49 billion in total impacts to earnings from currency volatility, while North American companies reported a staggering 3,583% increase in foreign exchange (FX) headwinds compared to this time last year.

All of a sudden, the task of FX risk management has for many firms gone from second order to a rapidly rising priority. And with many developed economies now edging towards recessionary territory, it’s no surprise that companies across the board are ramping up FX hedging as a result of this heightened volatility.

So, with FX headwinds set to persist throughout the remainder of 2022 and beyond, how is this volatile climate affecting corporates and what can firms do to mitigate the impact of currency headwinds?

The changing face of FX risk management

The pressure on corporates, a segment of the market that has traditionally struggled with FX risk management, is intensifying as they adapt to an increasingly volatile environment.

According to MillTechFX’s own 2022 CFO FX survey, 59% of corporates have experienced increased FX risk due to heightened volatility. Moreover, 89% of corporates that do not hedge currency risk are now considering doing so, highlighting the renewed focus of many companies on hedging.

Firms are subsequently adapting their hedging strategies to make sure this risk is managed effectively. During calmer times pre-Covid-19, we found that some corporates moved towards more exotic products. In recent months, we have noticed many reverting back towards the more straightforward linear products such as forwards which are more liquid and easier for corporates to unwind should the market move against them.

MillTechFX’s survey also found that the corporates are hedging a high amount of their exposure – with the average hedging ratio at 56% - and that instead of locking in rates for twelve months or more for FX forwards, the average length of hedges is five months.

This is particularly interesting as it indicates corporates are clearly balancing their valid concerns around profit erosion with the need to be fluid in the face of fragile supply chains, weakening consumer demand and rising inflation. Likewise, shorter hedging lengths means they have flexibility to adapt to the changing market rather than locking in a rate for a long time, enabling firms to adjust their exposure if they need to.

New challenges, old processes

Despite the renewed focus on managing the bottom-line threat of currency movements, our survey findings show that many firms still lack the necessary tools to mitigate this risk, with over a third (35%) of corporates rating their FX set up as below average or worst-in-class.

One of the main reasons for this is the reliance on manual processes, which can be cumbersome and time-consuming. 36% of senior finance decision-makers rely on email for instructing financial transactions, with 29% relying on phone calls and 31% having to send or upload files.

All of this internal, manual and siloed communication is extremely inefficient. And this is just for one, single trade. Many organisations execute tens or hundreds of trades every month with different products and mechanics. This entire process is a huge drain on time and resources. Corporate treasury teams subsequently spend around 1.85 days per week on FX-related matters while nearly half (47%) of those surveyed said they spend 2-3 days managing such matters.

As a result, it’s unsurprising that many organisations are seeking to embrace digitisation to improve the efficiency of operational practices, with nearly nine out of ten (89%) corporates seeking new technology platforms to automate FX operations.

The road ahead

The FX market is notoriously opaque and at times, long-winded. The process of booking and settling an FX trade involves multiple steps, including price discovery, calculating the FX position, waiting for confirmation, entering payments and process settlement. What’s more, transaction costs can be hidden in the FX spread, typically calculated as the difference between the traded rate at the point of execution and the mid-market rate at that time.

While there will always be some that don’t hedge their FX risk at all, those that haven’t are now considering doing so given the volatility and uncertainty facing the market.

Looking ahead to the next twelve months, firms should get the right processes in place now and seek alternative technology-driven solutions that can help manage FX risk more effectively and protect their business during these turbulent times.

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