Risk Management

Turning Currency Volatility Into A Global FX Strategy

Supply chains are globalizing even as rising protectionism threatens to place new challenges and barriers on those trade partnerships. Exposure to the risks of endless shifts of foreign exchange (FX) rates keeps executives on their toes: Deloitte recently found FX volatility to be the most common concern among surveyed corporate treasurers.

Yet, understanding and developing a clear strategy for FX risk mitigation can be elusive, even for the largest firms. Studies also show that most executives agree their top challenge is market volatility and the struggle to determine when — and how — to hedge currency risk.

However, foreign exchange risk mitigation goes beyond hedging, said Mark Frey, COO at Cambridge Global Payments. He told PYMNTS’ Karen Webster that, even for businesses considering FX risk for the first time, it’s never too late to make smarter decisions about their international operations. Where companies often trip up, though, is relying on data from business that’s already been done to make those informed decisions.

“Corporates should be proactively looking at currency risk,” added Frey. “It’s not just a residual of the business they are doing — that’s the trap many organizations, and even financial entities, fall into.”

Today, proactive risk mitigation is much easier said than done. In a world of shifting political winds, rising protectionism and trade disputes, global uncertainty very quickly translates into FX volatility. According to Frey, the current economic climate is particularly affected by sudden policy shifts that may not necessarily be rooted in sound economic fundamentals. This can expose companies to risk, explained Frey — even firms that may assume they are immune to currency fluctuations.

A business that conducts trade with an international partner, but with contracts solely denominated in the U.S. dollar (USD,) may assume their company is not exposed to such foreign exchange risks. Not so, said Frey. For instance, the appreciation of the Chinese RMB means that the same USD $10 million a company may send to a Chinese business every month results in less purchasing power and leverage. Even if a business only deals in USD, fluctuations of other currencies create risk.

Other firms may assume they’re too small, or that international trade volumes are too low, to render FX risk a critical component of their operations. According to Frey, if an exchange rate shift of more than 10 percent would negatively impact a company’s PNL (profit and loss) or ability to generate revenue, then, regardless of size, that company should deploy an FX risk mitigation strategy. That’s because mitigation against currency volatility isn’t an isolated endeavor.

“Risk management is not in isolation from the CFO seat when it’s done well, especially for a firm significantly involved in international business,” said Frey. “It dovetails into pricing decisions — how to price products and services you ultimately sell to end customers — or where and how you negotiate contracts as a manufacturer. It becomes an organizational philosophy and dovetails into how you make decisions with respect to running your business across borders.”

Foreign exchange management may affect the payment terms offered to a supplier, for example, or whether a company offers credit to a business customer in the supply chain.

“Currency risk management isn’t just about executing forwards and options, selling one currency and buying another,” said Frey. “A material portion of that risk can be mitigated with the structure of pricing agreements, how you structure contracts or payment terms. You don’t necessarily have to take out financial instruments, but you can effectively mitigate risk with business agreements.”

Since FX risk mitigation touches so many aspects of the enterprise, Frey said this area is benefiting from the wave of technology adoption in sectors like accounting and treasury management. Data from these platforms is instrumental in accelerating risk analysis, Frey explained. APIs are instrumental in pulling data from treasury management, accounting and other systems in real time, and facilitating automated reports and analysis that allow for more efficient decision-making, he said. This, in turn, means companies can take a proactive stance with their FX risk management strategies — even in times of political uncertainties.

“The goal,” said Frey, “is to manage downside risk and ensure flexibility so that, in the event there are favorable risks, you’re not mitigating a favorable outcome away.”

It’s a lofty goal, and while modern technology is capable of achieving it, the market is continuously looking for other tools to provide a catch-all solution to some of the largest points of friction in FX risk management. The conversation today invariably turns to cryptocurrencies, but Frey pointed to the transaction costs, lack of liquidity of crypto assets and the even more extreme volatility of cryptocurrencies, which make such technology a less-than-stellar option for hedging and risk management — at least for now.

Instead, Cambridge is investing in country payment rails, which Frey said can “very quickly, very cost-effectively for pennies on a transaction, and with the ability to see payments in real time through a technology platform,” provide the type of cross-border money movement and hedging services companies need.

“Problems won’t necessarily be solved by a crypto,” he said. “[They] will be solved by traditional rails.”

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