In Q4 2018 FX negative impacts continued to rise, particularly for Europeans*, and stood at $38.85 billion. Companies worldwide are continuing to report a decline in earnings due to FX losses on operations. The reason is that often, currency fluctuations impact a company’s cash flow and earnings differently. Earnings at Risk (EaR) is a calculation of the possible deviation to earnings due to FX rate movements at a specified confidence level and over a time horizon, while Cash flow at Risk is a calculation of the possible deviation in expected cash flows due to FX rate movements over the same period. Therefore, hedging certain cash flows may negatively impact earnings at a group level. It is all a matter of balance.
Bloomberg has developed a new approach which is based on an understanding of the tradeoff for each specific company as well as the group entity. It enables companies to develop an optimization strategy in which they choose where along the spectrum of Earnings-at-Risk vs. Cash-Flow-at-Risk a firm needs to be.
Bloomberg user, Constellation Brands, now manage both their earnings and liquidity with the Bloomberg Cash flow at Risk (CFaR) and Earnings at Risk (EaR) optimization tool, see figure below:
Source & Copyright©2019 - Bloomberg
“It took a little while to grasp the interplay between the concepts, but once we did we found it to be extremely valuable and perfectly in line with our vision of where we wanted to take our hedging program,” says Paul Sciarratta, FX Derivative Trader for Constellation Brands.
By implementing Bloomberg’s optimization risk management tool, Constellation Brands treasury has enhanced the way it manages risk in a way that benefits the treasury team, senior management and the business as a whole. Gone are the days of explaining to the senior leadership why hedging 80% of an exposure is a better strategy than 75% or 95%. Now when treasury presents currency risk, they can clearly assign the dollar value of foreign exchange risk to financial results with 95% confidence.
“This risk management strategy has dramatically changed the way we speak to senior leadership about risk; we now have a holistic view of currencies’ impact on earnings and cash flows which we can more easily explain,” concludes Shneydman.
Mark Lewis, Bloomberg's Head of Corporate Treasury Product, Bloomberg commented, "Corporate FX losses are material and continue to make headlines. Many treasurers are now amending their treasury risk policy by implementing a more dynamic hedging model that enables the company to minimise Earnings at Risk through risk optimisation tools."
* FireApps Currency Report, January 2019
CTMfile take: This is a breakthrough. This is the new standard in FX corporate risk management: optimising your balance of currency earnings-at-risk vs. cash-flow-at-risk.
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