8 Common Mistakes Companies make in FX Risk Management
Effective FX risk management is a challenge for many companies. Executives have always struggled with the high volatility and significant uncertainty. It remains critical that companies consider their approach to currency risk management and ensure that their programs are truly meeting their objectives. This insight highlights 8 key areas that companies should be aware of when evaluating their approach.
1- Speculating vs Hedging
A well implemented hedging program should not be reliant on taking directional market views. The goal is to reduce volatility and provide certainty to the business. If you find yourself spending a lot of time reading market outlooks and analyst reports, alarm bells should be ringing. Sure, there is nothing wrong with building some optimistic outlooks, but making hedging or planning decisions based solely on trader views often ends in pain. When a company takes a speculative stance on a currency movement, they become increasingly vulnerable to potential FX losses - particularly if the hedging approach is taken without some sort of protection.
2- Paying Too Much When Trading FX
Forex trading is very profitable for banks & international payment providers, in many instances they are being handsomely rewarded for very little effort. FX is an unregulated space and FX charges are rarely viewed as a line item, so the ‘soft commissions’ go unchallenged. It’s important to understand the market dynamics, and know how to tell when you are being overcharged. To protect yourself from receiving unfair rates, there are some simple measures you can take. For instance, never email for a quote without having a reference point.
3- No FX, No Exposure
It is not uncommon to hear ‘we don’t trade FX, and don’t have currency exposure’, only to later find out that business has international operations or price lists in different geographies. This is an example of an indirect currency exposure. Significant currency swings can adversely impact competiveness and cost the business. Even when pricing is in your domestic currency, the other party may have seen a significant shift in purchasing power. Knowing how to approach these issues and communicating significant changes within the business can yield significant improvement and peace of mind.
4- Risk Management Discipline
A common mistake is to let emotion creep into FX decision making. The market moves quickly against the company and you hope it will bounce back soon… Without controls and program guidelines, these situations can quickly deteriorate. Good controls and careful monitoring of ‘worse case scenarios’ are better options than praying for a reversal. It’s important to obey the parameters of a well thought out forex policy.
5- Benchmarking and Reporting
Many managers fail to keep an accurate record of hedging activity and the impact on an open exposure. This is not simply keeping an accurate trade blotter; after all, many individuals in charge of the FX exposure are finance professionals. This is about being able to answer questions such as, what is my average hedge rate? How much does the market have to move before the budget rate is at risk? Knowing this information and reporting it regularly will keep the knee-jerk reactions to market moves in perspective, and also give peace of mind to the organization.
6- Analyzing FX Results in a Timely Manner
For companies that engage in foreign exchange risk management practices, a performance evaluation should be completed at the end of each reporting period. It’s important to promptly isolate factors hurting FX performance, so that appropriate adjustments can be implemented, while continuing to maintain the forex policy objective.
Having a thorough understanding in forecasting the company’s exposure can significantly enhance the effectiveness of a risk management program. We understand, business situations evolve and it is not always possible to get the ‘perfect’ forecast, however, this should not hinder you from hedging FX risk going forward. A good FX program will allow for forecast variance. Even if your sales director cannot nail down the expected A/R to the nearest dollar, it does not mean you should do nothing.
8-Maintaining the Status Quo
As the stakes are so high in foreign exchange, it can be perceived that it’s “less risky” to maintain a company’s historical approach, as it’s always been done that way. However, if the approach isn’t working and is creating direct or indirect FX losses, a fresh evaluation is probably long overdue