Developing and implementing a hedging policy: Managing cashflow exposure is key to informed hedging practices

With continuing uncertainty in the global economy, central banks are using interest rates as levers to manage regional inflation. This increases currency volatility.

Thus foreign exchange (FX) risk management increases in complexity for many small and mid-size enterprises (SMEs) because most of their cashflows are subject to changeable exchange rates.

While your organization may be focused on driving a robust FX risk management practice, it is a multi-faceted undertaking, involving a range of analyses, modelling outcomes, and “decision gates.” Taking it step by step makes it much less daunting.

In our blog series on developing and implementing your tailored hedging strategy, we take a ‘best practices’ approach to help you understand the process and outline the steps you may take to analyze exposures, create a hedging policy, implement and manage your hedging strategy.

The first step in risk management is to analyze FX exposure and measure the effects of the movement of rates on the company’s liquidity.

Monitoring cashflows from distributed windows or different platforms is a time-consuming, painstaking process.

Your liquidity is tied to cashflows, which may help you identify transactional risk that could occur from a specific exposure.

Move past this stage with flying colors and you can execute an informed hedge to mitigate your exposure.

Analysis of the risk profile for each currency in your cashflow forecast takes you far in defining your tailored hedge strategy—one that matches your business profile.

Here are a few best practices that may help you streamline your risk exposure analysis:

• Structure your analysis. Analyzing exposures could happen by the entity, business unit, or division, or even on the group level. Whether you are managing FX risk using a spreadsheet such as Excel, or another tool, ensuring you always have all the data available will help you to make the most thorough exposure analysis for your group or smaller entities.

• Balance opportunities and costs. Few companies perform a structured risk analysis to identify optimization opportunities in such a way that there is a perfect combination of minimizing losses and potentially gaining wins from market fluctuations, whilst keeping the cost of hedging in check.

• Set your FX Risk Policy. Do you have an FX Risk policy in place? That can help you to set your medium-term and long-term targets. For a coherent response to FX volatility in cashflow forecasts, hedged positions and business profile, a holistic FX policy will help define thresholds that you can benchmark while managing FX exposure. It is important that your FX risk management policy buys you enough time for the effects of the commercial response to be evident. That depends on your business cycle: some businesses plan monthly; others quarterly; stull others annually.

• Start with a Currency Map. The challenge of creating your foreign exchange risk management policy may seem a little overwhelming: in practical terms, where do you start? Put simply, if there is any degree of complexity involved, start with a ‘Currency Map’ to visualize market fluctuations alongside your cashflows.

• Your base currency may not be the transactional currency that is part of your cashflow forecast, and mapping the underlying exposure in your base currency becomes tedious without an automated cashflow mapping tool. Evaluate your options and look for a cashflow risk management tool that can accommodate the elements of your unique FX strategy.

• Consult an expert. Engage with subject matter experts like Corpay’s analytics team, who have developed tools to help clients perform exposure analysis and reporting as well as hedging, or leverage a self-serve risk management platform to visualize your cashflows.

Also, bear in mind that your hedging tactics may need to adapt to changes in your business and in the markets.

Capturing your exposures and recognizing potential sources of risk is a good first step in developing and implementing a policy that helps you achieve your goals.

In future posts, we’ll describe best practices for setting your goals, developing your policy, and monitoring performance. Understanding the process can help increase your confidence in managing risk no matter where your business takes you.