A Greenwich Associates report has examined how corporations think about FX and how this influences their trading behaviour relative to financial investors, who are more often in the market structure spotlight.

In a survey of corporates conducted by Greenwich Associates, a surprisingly small number of the world’s largest companies employ sophisticated techniques designed to assess and manage their foreign exchange risk.

"Corporations are arguably the most important customer segment in FX, and we have noted in other research the lengths to which banks and platforms will go to retain them," said says Ken Monahan, senior analyst for Greenwich Associates Market Structure and Technology and author of The Elephants in the Dealing Room: A Study of Corporate FX Clients. "After all, they are the ultimate end user, and for them, FX is largely a cost."

Companies use FX markets to hedge currency risks in the course of their businesses. However, relative to banks and financials, companies’ FX needs and strategies are incredibly diverse, varying dramatically depending on the nature of their businesses, their amount of cross-border activity, the structure of the company, and ownership structure.

What is best practice?

Because the corporate FX business is so heterogeneous, it is difficult for companies and the banks that service them to establish universal best practices. In fact, almost 60% of the corporate treasury professionals participating in a recent study by Greenwich Associates agree that “the circumstances and the risks of any given firm are diverse enough that it is not possible to establish best practices” for FX. Conversely, only 29% of corporate treasurers believe that there are clear best practices for hedging.

Despite this variation, it is striking that only about one in five of the large companies taking part in the study employ the VaR or “variance at risk” framework, such as “earnings at risk” or “cash flows at risk.” The VaR methodology is designed for precision hedging strategies using relatively sophisticated instruments and analytical methods that take into account the historical variances and correlations of the various exposures.

“Since our study was focused only on the largest and most sophisticated firms, our original hypothesis was that the risk management philosophy would be as sophisticated as the firms themselves. This wasn’t so,” said Monahan.

Slow steps to becoming data-driven

One reason for the low level of VaR usage is that the more sophisticated strategies are only as good as the data that feed them - and companies in the study have little confidence in the quality of their own data. The lack of reliable data and the complexity of the task at hand makes companies reliant on the FX dealers, with treasurers often asking their dealer counterparties to conduct the VaR analysis on their behalf. 

“Although FX dealers provide critical support to companies, corporate treasurers are well aware that their client relationships with FX dealers are driven as much by bank lending and cash management functions as by quality of service provided in FX,” says Monahan.

The Greenwich report provides a detailed analysis of the corporate FX market, including an examination of the top risks managed by treasury departments, how corporates make decisions about FX, the strategies employed by companies to hedge FX risk, relationships with FX dealers, and the primary mechanisms corporates use to execute trades. These include the increasing use of more complex techniques like “parameterised auto-execution” and algorithmic trading.

Methodology

Throughout June and July 2019, Greenwich Associates interviewed 97 FX investors as a part of its annual Market Structure and Trading Technology Study. Respondents were asked how they select an FX trading platform, how they determine quality execution, as well as the influences for selecting an FX algo. In addition, Greenwich Associates conducted electronic interviews in the second half of 2019 with 76 corporate treasury executives from large, industry-leading multinationals based in the US to explore the evolving role of the corporate treasurer. Topics included how corporate treasurers’ objectives are defined, what methods and tools they use to achieve those objectives, and where there may be shortcomings in the tool set. In addition, we conducted several qualitative interviews via in-depth conversations in order to dive more deeply into how specific corporate treasury staff manage their risks.

Addressing FX risk management

Last month, CTMfile conducted a well viewed web chat with Sandra Koch from Hedge Trackers, which is worth watching in light of the Greenwich report. In the conversation with Jack Large, Sandra Koch talks about the FX cash flow hedge relationship timeline, covering forecast/exposure management workflow, pre-trade workflow and management, and FX execution and post-trade compliance and reporting. The web chat also includes a demo of Hedge Trackers' CapellaFX system.