A large number of European multinational corporations have seen their profitability take a hit as a result of a recent surge in volatility in the foreign-exchange market, according to a report from risk-management technology provider FiREapps.
During the third quarter of 2017, 54 out of 350 Europe-based companies reported a negative impact on their earnings as a result of currency moves.
Of those, 26 quantified their impact, accounting for a collective loss of €3.63 billion ($4.27 billion). This was a sharp increase on previous quarters, with similar losses not seen since 2015.
“FX tends to be quite cyclical in that volatility comes and goes in particular currency pairs,” says Wolfgang Koester, chief executive of FiREapps. “When markets are quiet, companies do hedge less and then when they get hurt they suddenly want to increase hedge ratios.
“We have seen that play out in the US over the past year, but European companies still appear to be largely under-hedged.”
Low levels of volatility have been a source of frustration for those alpha-seeking hedge funds and investors that seek to use FX as an investment asset class, but it has also resulted in a tendency among some corporates to under-hedge their exposure.
Allowing hedge ratios to decline during times of low volatility can be dangerous as it leaves companies at risk when currencies suddenly begin to move again.
Deutsche Bank’s currency volatility index (CVIX), which provides a daily measure of volatility in the FX market, shows how suddenly volatility can spike and fall. In April 2017, for example, the CVIX fell from 9.99% to 7.93% within a day and has not since surpassed 9%.
|% change FX volatility: CVIX|
|Source: Deutsche Bank|
“As the dollar began trending in Q3 and volatility increased, corporates that were not properly hedged saw a financial impact,” says Fabio Madar, global head of FX coverage at Deutsche Bank.
“We have now had years of low volatility in FX so there was some complacency and a significant number of firms were not fully hedged for the dollar move.”
However, vulnerability to currency moves is not only about the rise and fall of volatility. Many corporates still do not fully understand their exposures, as they do not have the reliable data or technology that is needed to set and execute a clear hedging strategy, according to Madar.
In 2014, Deutsche Bank partnered with FiREapps to give corporate clients greater insight into their currency exposures and help them to manage their risk with greater confidence and precision.
Madar believes that with more automated, systematic hedging, corporates should be able to avoid being caught out by big currency moves.
“Many corporates still don’t have very accurate data about their exposure and they use accounting systems such as SAP or Oracle rather than risk-management systems, which means there is a lack of key information and appropriate hedging,” he says.
“Having proper systems in place can give companies close to 100% accuracy on their exposure so that they can then decide to what extent and duration they should hedge.”
While the FiREapps study shows some European companies have taken a hit on FX, it also suggests North American firms are generally faring better than in the past. A collective loss of $1.01 billion was reported in Q3 2017, down from $6.71 billion in Q2, having been as high as $33.94 billion in Q4 of 2015.
The study only provides a snapshot, but it does suggest US companies might be better risk managed for FX moves than their European counterparts.
The ideal scenario, says FiREapps’ Koester, is for treasury departments to use technology to analyse their currency exposures on an ongoing basis so that they can create a complete view of risk rather than having to respond to every move on an ad-hoc basis.
“Sophisticated corporations are moving away from analysing individual currency pairs that happen to be volatile and are instead using technology to look at how the entire portfolio of currencies is impacting their financial statements,” he says.
“Boards don’t want to talk only about EUR/USD, for example – they want to have a broader conversation about risk.”
Since the Q3 analysis, FX markets have remained fairly active as US tax reforms and speculation over interest-rate rises have kept currencies moving.
EUR/USD, for example, which is trading at around 1.24, has been moving steadily upwards since the start of the year, while USD/JPY, now at 110, has moved in both directions.
January was a particularly busy month, notes Deutsche’s Madar, with a lot of hedging among corporates.
“When volatility is low, hedging often tends to decline and corporates are caught off-guard when a trend begins, but this is really because processes are not sufficiently automated and there is still too much discretion involved,” he says.
“Within 10 years, there should be much less human intervention, hedging will be more systematic and losses on FX moves should be less.”