Is FX hedging Policy Required For a Corporate?

Is FX hedging Policy Required For a Corporate?

24 Apr 2020 03:08 PM

Managing risk in a financial market is required to keep a check on the adverse movements in the instrument of the market. Particularly in the foreign exchange market, the risk tends to be higher given the global presence round the clock working 24x7 all five days week. Thus hedging is to formulate strategies in order to offset any open current exposure. Fundamental economic indicators or global events tend to make the forex market fluctuate which increases the overall risk for a corporate forex portfolio.

The forex team of the finance department is ideally responsible for the net positions, be it gains or losses, associated with the adjustments made to the forex hedge already done. During current times, due to several countries on a lockdown, the commercial activities have come to a standstill which is forcing non-delivery of goods for exporters and which thereby cancelling the receivables. But along with cancellations of orders leading to revenue loss, comes the problem of already over hedging forex exposure. And with the local currency losing its value further, these contracts are being cancelled at huge losses. Some risks when not managed leads to double whammy losses.

Hedging helps in reducing cash flow uncertainties which thereby aids in making informed financial decision. Be an exporter or an importer both need to formulate a forex hedging strategy given the huge volatility in the forex markets. So the necessity of hedging forex has to be understood as it is the need of the hour and it delegates the mitigation of risk check point to others in the vertical. Flip of a coin doesn’t decide a forex hedging strategy rather it is an informed decision one takes. Since it goes through some levels of management, it automatically eliminates the risk of wrong forex decisions due to the laid down forex policy. 

A well executed plan is the need of the hour than just making a policy which is not implementable. Thus a well defined strategy should be in writing which helps create accountability of the policy thereby removing any ambiguity on how the forex risk is to be managed. Often the task of formulating a policy itself takes time and is procrastinated before a jolt in the markets makes it an urgent agenda. It is important to know if the existing finance team has to capability to manage forex risk which can be lead to putting a policy in place. Sometimes the bandwidth doesn’t permit quality time which is required to come out with an appropriate policy. Would the service if outsourced provide a better solution?

If a practical approach isn’t adopted, business decisions may be to hedge cent percent of the forex exposure or in an appreciating currency scenario, not to hedge at all in the hope of better rates. A forex hedging strategy has to spell out the method which has to be followed on different scenarios. If the method is not laid down, then the policy formed will be sufficient to ‘hedge against risk’.

Key points to ponder on for practical implementation of a forex hedging policy

  • Aim of hedge – what is the main objective of hedging the currency? Margin protection or consistency?
  • Hedging transactions – only committed transactions are to be hedged or based on past performance, a forecast exposure is to be hedged? Based on transaction date or maturity date?
  • Strategy – what strategy is to be followed in implementing the hedge – a strategic or back to back hedging.
  • Tools and quantum – what tools are to be used to execute the hedge and if it’s a forecast then for what time period should the hedging be made for what percentage of the forecast or commitment.
  • Review – making a policy may be beneficial for a period of time but with changing times, and interlined economies, one needs to review the existing policy to monitor the changes required to keep the policy relevant.

More often than not, a written policy serves the purpose when done with a team of experts. Every corporate may have a different strategy in place to make an executable forex hedging policy. Keeping the above points in mind, liaison with forex experts who would assist in formulating the forex hedging policy to tackle and manage uncertain and volatile situations. Make the policy a priority by reviewing it as frequent as its dynamics.

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