A survey of UK-based CFOs published recently by MilltechFX found that corporates had relaxed their attitude to volatility risk over the last year. Just 70% are hedging their currency risk, compared with 89% in 2022, and there has also been a sizeable fall in the average hedge ratio.
The findings of Kyriba’s latest currency impact report, meanwhile, might suggest that corporate attitudes are reasonable, given a decline in quantified currency impacts and a fall in the average negative impact of currency movements for the first time since 2021 among the 1,200 multinationals covered by Kyriba’s report.
As long as key risk markets remain well behaved and investors continue to expect a soft landing in the US, volatility in FX will be subdued
David Leigh, Deutsche Bank
Many of the big FX banks are equally relaxed about the prospects of high market volatility in the short term, despite divergence in central bank rates policy.
Implied FX volatility has remained relatively low in the G7 currency pairs, despite heightened geopolitical risk since late summer 2022, which is surprising given the intraday volatility observed in other products, such as government bonds and equities.
“In the last quarter, realised volatility has consistently been lower than implied volatility, which will maintain downward pressure,” says Alex Price, director, large corporate FX sales at Lloyds Bank commercial banking. “In the absence of an unforeseen trigger, most G10 FX pairs should remain in a low volatility phase.”
With most central banks entering a long plateau in their hiking cycles, movements in front-end rates – and, by extension, FX – are likely to remain subdued, suggests Deutsche Bank’s European head of FX, David Leigh.
“Geopolitical risk remains a potential source of volatility, but as long as key risk markets remain well behaved and investors continue to expect a soft landing in the US, volatility in FX will be subdued,” he adds.
But Holger Zeuner, head of EMEA thought leadership, corporate sales, markets and securities services at HSBC, warns that extreme moves can be sudden and caused by a variety of underlying factors the market may not have expected.
“It has become more important for corporates to think through the implications of stronger currency moves on their financials,” he says.
It has become more important for corporates to think through the implications of stronger currency moves on their financials
Holger Zeuner, HSBC
According to Jocelyn Tan, global head, financial markets e-distribution at Standard Chartered, Asian corporates have experienced a period of volatility in a number of regional currencies and many recognise the need to review their risk-management policies to plan for future extremes as volatility has become the norm.
She says currency weakness is putting pressure on emerging-market central banks to hike rates to re-establish currency stability.
“Bank Indonesia surprised markets with a hike to 6% in October, and we could see more emerging-market central bank hikes in a similar vein,” she adds.
Andy Gage, senior vice-president of FX solutions and advisory services at Kyriba, cautions that although the downward trend in Europe and the US is substantial, “we are by no means out of the woods regarding a currency market fuelled in large part by continued inflationary pressures, interest-rate moves and a general sense of uncertainty from a variety of geopolitical events.”
Tech solutions
This would be less of a concern if corporates had more confidence in their FX technology. However, more than three quarters of UK and US-based corporates surveyed by MilltechFX said they were looking into new technology and platforms to automate their FX operations, with forecasting exposure and cost calculation proving especially challenging.
Certain clients have embraced new technology platforms designed to improve exposure identification and forecast accuracy [but these] can be challenging and costly
Brandt Portugal, Citi
“Aside from behavioural adaptations to hedging through adjustments to hedge ratio, tenor and instrument, certain clients have embraced new technology platforms designed to improve exposure identification and forecast accuracy,” says Brandt Portugal, head of Western Europe corporate FX and global head of corporate eFX distribution at Citi. “However, these solutions can be challenging and costly to implement.”
He also suggests corporates have been slower to adopt third-party data-analytic providers due to their fee-based model.
Corporate clients have traditionally relied on their treasury and accounting teams, with input from internal purchasing and delivery, to forecast exposures. This has placed a burden on treasury since if there were inaccuracies in the input data, the treasury team would need to take action to address this by adjusting their hedges through the life of the product.
Larger corporate clients have relied on multi-bank FX platforms to achieve competitive price tension for their regular market size flow FX business, explains Price at Lloyds.
“The main area of technology growth has been around the cost of execution for larger spot trades, either as benchmark orders or over bank algo platforms,” he says. “There are now several independent providers that will benchmark cost of execution for clients. Clients of banks with algo offerings may have access to proprietary platforms to evaluate their cost of execution and the effectiveness of their spot execution strategy.”
In Europe and North America, corporate treasurers continue to appreciate advice from their banks on best execution and there is continued use of multi-dealer platforms for smaller tickets, and FX algorithms and orders against fixes for larger sizes, concludes Tan.
“However, in emerging markets where there are restrictions relating to FX dealing by local regulators, we see a continued need for proprietary platforms,” she adds.
