CitiFX Publication - From Crisis Management to Business Recovery

5 5 Foreign Exchange Guideposts for Corporates in a time of COVID-19 For example, a core issue many companies face is that business disruption is widening the variance between previous commercial forecasts and the new operating reality. Depending on the approach taken, many companies may now be over-hedged. Set aside the potential shortcoming of the existing risk management policies in-place, this may make hedges ineffective under accounting treatment and result in P&L volatility. It may also drive inefficient credit and cash utilization, at a time when liquidity is at a premium. Consequently, it would be appropriate to reassess risk management policies to avoid unintended financial risks and costs. The objective would be to determine whether to revert to hedging ratios as in the current policy, or adopt an alternate hedging approach. If the latter requires risk management policy refinement and C-suite engagement, so be it. This is not a time to defer hard decisions. With that in mind, the following framework can help in determining the appropriate level of hedge adjustments. For many companies, the suggested actions in the bottom left quadrant of the Policy Assessment Matrix (Figure 2) may require C-suite engagement. To avoid further depletion in cash reserves, consider adjusting hedges to levels that meet revised forecasted cash flows rather than unwinding existing out-of-the-money hedges to meet current policy. In a business environment with heightened uncertainty, the use of forwards, although an effective risk mitigating tool under stable market conditions, may not be the best and only tool considered in the FX risk management process. For example, as described in the Policy Assessment Matrix above, many corporates have needed to unwind existing forward Prioritise Liquidity Prioritise Risk Mitigation No Policy Change. Based on revised forecast, make the necessary hedge adjustments to meet the minimum policy ratios. No Policy Change. Based on revised forecast, make the necessary hedge adjustments to meet the maximum policy ratios. Update Hedge Policy ratios to be forecast based . Allow for hedges to be adjusted to fully match the new forecasted cash flows. No Policy Change. Based on revised forecast, make the necessary hedge adjustments to minimise negative cashflow. Positive Negative Cashflow generated by unwind Depleted Ample Cash Reserves contracts due to its change in forecasted cash flows. This has resulted in unexpected strains on its current liquidity position and even earnings. We recommend the use of options be examined to determine if the cost associated with deploying options to mitigate future uncertainty is potentially less than the potential unwind of forwards as the market continues to adjust to the new normal. This is not to state that options are the only instrument for mitigating FX risk in a volatile market. However, if a corporate can identify which currencies are cost effective to utilise options, it could benefit in several additional ways; mitigate credit utilisation at settlement and increase assurance for forecast revenues and earnings. A sustained uncertain business climate certainly underscores the importance to review current foreign exchange hedging strategies. As an approach, first, perform scenario-based forecasting across a range of potential business outcomes. Next, adopt a framework to determine the appropriate hedging strategy, reflecting the company’s near term liquidity needs and accepted risk tolerance. The outcome may call for refinements to the risk management policy and C-suite engagement. Figure 2: Policy Assessment Matrix for Hedge Assessment