Hedging complacency adds to corporate FX risk, Citi finds

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By:
Paul Golden
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Citi’s latest global corporate benchmarking survey shows that companies are worryingly complacent about their potential exposure to emerging market currencies and remain reliant on manual processes to manage risk.

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Emerging markets are a growth sweet spot for many corporates. But concerns around economic stagnation and trade relations have weighed heavily on emerging market currencies as the US and China continue to butt heads over tariffs.

In this context it might be expected that corporates operating in emerging markets would have a distinct market hedging policy for currencies outside the G10 group of nations. Yet although more than 80% of respondents to Citi’s recent global corporate benchmarking survey reported having exposures to emerging market currencies, a similar percentage admitted that they didn’t differentiate between emerging market and developed market hedging practices.

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Jaya Dutt, Citi

Jaya Dutt, global head of risk management solutions for corporate FX at Citi, says that while most of the companies surveyed have an enterprise resource planning (ERP) or treasury management system (TMS) in place, integration between these systems is limited and risk management processes remain largely manual.

“As a consequence they are relying on the hedging policies they already have in place and are constantly looking to revamp these policies, which extend across the full breadth of their FX risk,” she says. “This can lead to capital losses and have a negative impact on loans taken out by local subsidiaries if risk practices don’t take account of emerging market currency volatility and liquidity.”

More than 90% of survey respondents have implemented cash-flow forecasting methodologies to improve visibility into future multi-currency cash positions and help identify natural offsets and opportunities for more effective liquidity and currency risk management. However, almost three in four (72%) rely on manual inputs as part of the forecasting process.

Inconsistencies

There are many processes that are still supported manually across treasury organizations, admits the EMEA head of Citi’s treasury advisory group, Duncan Cole.

“Automation technology is available and affordable, but there are inconsistencies in deployment,” he says. “Coupled with the fracture in connectivity between TMS and ERP systems (in some cases multiple ERP systems) where the underlying commercial flows are, this leads to the use of manual processes to connect data.”

Almost two thirds of the companies who participated in the survey noted that their TMS was either not integrated or only partially integrated with their ERP system, which provides the required underlying business data to identify risk exposures.

Another area of missed opportunity highlighted in the survey relates to intercompany netting, where all the subsidiaries in a corporate group make payments to – and receive payments from – a clearing house or netting centre for net obligations due from other subsidiaries in the group. Fewer than half of the companies surveyed by Citi use intercompany netting.

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Duncan Cole, Citi

“Intercompany netting is one of the first steps to driving treasury efficiency,” says Cole. “Intercompany flows are often a source of noise when treasury is trying to consolidate its true liquidity exposure because of manual reconciliation and settlement between subsidiary companies. Even when a company has deployed intercompany netting – which we see as being the first step towards creating an in-house bank for managing FX risk centrally – it often doesn’t include all the intercompany flows.”

The fact that 9% of respondents to the benchmarking survey didn't have a formal FX risk management policy also seems puzzling. 

Erik Johnson, global co-ordinator for CitiFX risk solutions, notes that for some of these businesses – particularly those which only operate within their domestic market – FX will have a limited marginal impact, although he recommends that such companies still have a policy, if only to clarify their response to an unexpected event.

One encouraging finding from the survey was that 71% of companies reviewed their FX risk policy at least once a year.

“In the past a review would usually only take place following an acquisition or a change in the business model,” says Johnson. “We see increased demand for studies looking at the impact of changes to volatility on portfolio risk. In a market characterized by low volatility and heightened geopolitical uncertainty, there is an opportunity for corporates to take a step back and use informed data and analytics to optimize currency risk.”