It’s that time of year. Treasury teams are making business projections for 2023 and plans for managing their foreign exchange exposure for the year ahead. The savviest treasury teams know that this is when planning exposure management is crucial. It’s now that you should start to plan hedges for the year.
But with a challenging macroeconomic environment, hard-to-predict exchange rate movements and stubbornly high interest rates and inflation, heightened exchange rate risk looks here to stay. It’s in this environment that treasury teams need to stay in line with their organisation’s risk appetite, meet their hedging targets and manage their FX risk and exposure.
So how can treasury teams and their organisations manage their FX exposure?
In this blog, we’ll explain the challenges treasurers face when it comes to managing their FX exposure as businesses head into 2023, and the strategies and new FX technology that can help you start the year right.
A challenging macroeconomic environment
One of the biggest variables treasury teams need to take into account is the big picture itself: the macroeconomic environment. Geopolitical events, rising inflation and high interest rates all affect a company’s exposure.
For many companies, the most important macroeconomic factor is the behaviour of the U.S. Federal Reserve and the US Dollar (USD), which strengthened over 2022. Will it strengthen or weaken in 2023, and how will that affect the company’s position? Considering how USD will perform is crucial to treasury teams’ plans for trading and hedging throughout the year.
For example, if a Norwegian business has payroll costs in USD, and the dollar strengthens against Kroner in 2023, then the company’s USD exposure will increase. Organisations can’t influence these events, but they can plan ways to reduce their exposures, whether transaction, translation or economic.
In this challenging macroeconomic environment, it’s crucial that businesses forecast their exposure so that they can mitigate their risk.
Regardless of how kind or challenging that environment might be, the number one task for any business looking to start the year right is to project future cash flows and understand their positions. The more accurate a business’ projections, the more likely they’ll have an accurate sense of their exposure.
But to achieve that accuracy, treasurers need transparency over their business’s data. What costs are coming in and going out, and when? Where are their assets, and in what currency? Which structural or operational setups might be impacted by currency shifts?
By understanding that, treasurers gain oversight and insight into their company’s positions across the board, and provide themselves with flexibility around when and how they can hedge their exposure. Making sure that they get this information at the start of the year is crucial, but there are issues that can impede this.
- A disconnected organisation: If teams don’t stay connected and communicate effectively, forecasts can be inaccurate and FX risk can increase. FX exposure risks can come from different parts of the business; without understanding where they are, the information on which treasurers make their projections might be incomplete or inconsistent.
- Insufficient tools and resources: Without being able to view the information that informs their exposure, or view their exposure in understandable ways, it can be hard for companies to get a handle on their risk. Also, treasurers need access to a certain amount of capital or credit facilities to reduce their exposure in alignment with their hedging policy. But if they aren’t able to understand the capital or credit they have at their disposal, or don’t have the tools to properly manage their exposure, they might not be able to reduce exposure effectively.
- Inadequate information: Without access to data from across the business, important information can get missed. Treasurers need complete data from different business units, locate and understand information buried in contracts (even when they’re not fully visible, for example, if a contract has currency terms), and be able to find this through accessible systems with organised data.
Strategies for mitigating exposure
In this context, companies need to make sure they’re starting the year right. They can do this by adopting strategies that help them get a clearer understanding of their exposure, helping mitigate their risk.
1. Respond to the strong dollar
Let’s look at a couple of corporate FX risk management strategies for a European business with exposure to USD.
Move money to your USD account
If a business based in Europe has costs in USD, and market indicators suggest the dollar will strengthen, they can hedge more EURs to gain access to USD earlier in the year. This helps businesses get ahead of the predicted rise in USD, bypassing the expected increase in exposure — and the increased costs.
Use forward contracts
FX forward contracts allow businesses to settle funds at a specified future date at an agreed rate. If a company predicts USD will strengthen, they can book a forward contract at an agreed set rate that takes into account the impact of a stronger dollar.
2. Understand and access the right data
Treasurers need to make sure they have the right information so they can trade at the right time and manage their FX risk. How can they do this?
Get your house in order
Sales need to keep CRMs updated so that treasury and accounting teams know which deals will close and when. In some cases, treasury teams only understand the full extent of risk once an invoice is raised and on the books, meaning that the risk has crystallised. Keeping open channels of communication helps reduce risk before this happens.
By gaining visibility over the organisation’s cash flow, treasurers can trade and hedge according to this. For example, if an organisation’s policy is to hedge 100% of the time, treasurers could potentially make a lot of trades daily. But if they know that a deal isn’t closing for months, treasurers can keep open the option to make a smaller percentage of those trades now, and cover the rest of their exposure later.
Align hedges with forecasts
It’s one thing to make accurate currency and exposure forecasts. It’s another to align your hedges with those forecasts. This is because projections change and treasurers need to check their hedges to continue to cover their exposure and align with their policy.
By providing access to transactions, new FX analytics technology helps companies map their previous trades to their future exposure, providing insight into when more hedges are needed to cover their exposure.
Set rate alerts
Using rate tracking tools, companies can set exchange rate alerts so they’re notified when a chosen currency pair reaches a price at which they want to trade. If a business has a rolling hedge policy, for example, with a target to hedge 50% of their exposure by October, rate alerts can help businesses cover the risk earlier at an acceptable price.
3. Continually monitor exposure
Alongside macroeconomic changes, natural fluctuations in the business also impact exposure. It’s important to set up systems to monitor exposure continually throughout the year to a) gain oversight over these fluctuations and b) be able to respond to them effectively. Businesses need to do this in a cost-effective way, too.
Managing FX trade margins
Responding to macroeconomic events and internal company processes is crucial. But many organisations are also missing one big thing: the margins banks charge them in their FX trades.
If businesses don’t understand the fees they’re paying their banks — or don’t even know what those margins are — the cost of managing FX exposure risk is going up without businesses even knowing it. High or excessive FX margins are an avoidable risk.
Strategies to manage your FX margins
By gaining transparency over true FX margins due to new FX technology, companies can regain control over their costs — not just for 2023, but for the long term.
1. Know what you’re paying
FX benchmarking technology removes the opacity that allows banks to include big margins to their trade fees. Using an FX benchmark tool that draws on real-time interbank data, companies input their currency pairs, the amount they’re selling or buying and their bank’s quote. The benchmarking tech then shows what the trade actually costs versus the margin their bank is making.
2. Trade, wait or negotiate
By understanding how much margin they’re being charged, businesses get more information to decide whether they should trade based on the deal being offered, wait for something better or negotiate with their bank.
3. Get forward as well as spot rates
Many FX rate tracking tools only provide spot rates. But the most comprehensive tech provides information on forward rates too. This helps companies see how their costs vary based on the timeframe they choose to settle trades. Businesses can get quotes for various tenors, helping them plan forward contracts that best fit their risk management and exposure policy.
4. Use neutral 3rd party data and multiple banks
Businesses do more with their banks than just trade. Banks provide loans and other financial services, so it’s important to keep a good relationship with them. By using third-party, neutral data insights to support conversations, businesses can improve their position — without spoiling the relationship. By keeping good relationships with multiple banks, companies can use those options as leverage in securing the best terms.
Starting 2023 right with Just’s FX Benchmark
Corporate FX risk management can be incredibly challenging. Currency risks can be hard to predict. The macroeconomic environment can be volatile. Treasurers need to reduce their exposure, but also do so at an effective price.
The key steps are:
- Understanding your FX exposure - what and how much will you need to buy and sell, and when
- Understanding the costs of trading and reducing risk
- Choosing the optimal time and contract lengths (or tenors) to trade
An easy way to get started is understanding the costs of trading and reducing risk. That can happen today with a free trial of Just’s FX Benchmark tool, which lets companies access real-time FX information — TOD and spot rates to two-year tenors. With FX Benchmark, any company can query the interbank market — the real prices that banks trade with each other — and can see how much the bank has added as a margin. This is the true cost of trading.
It’s simple. Companies can input their trade details (like the currency pair and the quote from their bank), and immediately see the margins their bank has applied to the trade. Then the decision is easy — trade, wait or negotiate. To see how Just can help you start 2023 right, try FX Benchmark today.