Is it time to review your hedging strategies?
As global markets continue to evolve, managing foreign exchange (FX) risk has become more critical than ever for global businesses.
With a strong dollar and rising rates, FX markets are becoming a little more unpredictable than in the recent past. The business objective is to reduce volatility as a result of foreign exchange, so hedging exposures in foreign currencies is a strategy that treasurers are now actively engaging. At EuroFinance’s 9th annual Global treasury Americas West Coast, treasurers from logistics real estate investment company, Prologis, Swiss-American multinational manufacturer of computer hardware, Logitech and the transportation giant, FedEx, discussed the challenges they face, the strategies they implement, and the tools they use to navigate FX risk in today’s rapidly changing environment.
Drivers of risk
Consider the global logistics real estate company, Prologis, generated approximately $1.0 billion or 17.3% of its consolidated revenues outside of the U.S. during 2022. Furthermore, approximately $10.2 billion or 11.6% of its consolidated assets were invested in currencies other than the US dollar at December 31, 2022.
If left unhedged, changes in FX rates can significantly impact the company’s financial performance. If the US dollar appreciates against the currencies in which Prologis generates revenue and holds assets, it would result in lower revenue and net operating income in US dollar terms, and also degrade the value of its foreign assets..
To manage its FX risk, the treasury team uses various hedging strategies, such as forward contracts and options, to protect against unfavourable currency movements. However, even known risks change and evolve and new risks can arise. Therefore, treasurers must continuously monitor and strategically manage their companies’ FX exposure to minimise potential losses and build-in forecast predictability.
“We are focused on hedging non-USD earnings and balance sheet exposures using financial derivatives in conjunction with the natural hedges created by the issuance of debt in the currencies of our global asset base wherever it is economical. It is also essential to build and maintain a consistent, programmatic approach to risk management.” Sarah Alloy, Vice President, Treasury at Prologis told delegates at the conference.
As of March 2023, the company holds FX derivatives for a notional amount of $2.7 billion to hedge foreign currency exchange rate risk related to both its foreign investments and the related earnings.
Meanwhile, as a leading global provider of consumer electronics, Logitech generates approximately 58% of its sales from international markets and operates a diversified supply chain across multiple countries and currencies. Therefore, FX changes can adversely impact profitability margins of sales in non-US Dollar-denominated countries but also on sales of products that include components obtained from suppliers in non-US Dollar-denominated countries.
The treasury team enters into FX forward and swap contracts to reduce the short-term effects of currency exchange rate fluctuations on certain receivables or payables denominated in foreign currencies as well as exchange rate exposure of forecasted inventory purchases.
“It’s essential to have a strong risk management foundation to help mitigate the impacts of currency fluctuations on our financial results…policy is reviewed and approved by the board annually, and the board is actively involved in discussions about risk management.” Jacqueline Pagano Head of treasury at Logitech told delegates. ”
The company’s FX derivatives portfolio stood at $329.3 million at the end of December 2022, as compared to $379.8 million a year ago.
On the other hand, while FedEx is a global provider of transportation, e-commerce and business services, the majority of its transactions are denominated in US dollars. Historically, its exposure to foreign currency fluctuations is more significant with respect to its revenue than expenses, as a significant portion of its expenses are denominated in US dollars, such as aircraft and fuel expenses.
Therefore, the treasury team has maintained a consistent strategy over the last five years, primarily focusing on hedging its balance sheet risk. This approach has been closely and actively monitored to prevent any unforeseen issues. Furthermore, In the past, the company hedged commodities such as fuel, but this program was discontinued in the early 2000s. Instead, a dynamic surcharge was introduced, which effectively serves as the company’s means of hedging fuel exposures.
Starting in 2018, FedEx’s treasury team developed another risk management focus when its treasury team decided to conduct a comprehensive analysis of its hedging practices, particularly after acquiring a Netherlands-based company with significant FX exposures. This in-depth review aimed to better understand both companies’ programs and identify ways to minimise their combined exposures. A crucial aspect of this process was to enhance governance and monitoring of the FX risk management program.
To streamline the management of FX exposures, the treasury team revamped its policies and implemented automation across its processes. Standardising processes across the enterprise facilitated easier management of these risks. Additionally, treasurers collaborated with other companies which played a significant role in helping them transform their FX risk management program.
Similarly, the treasury team at Logitech has made significant strides in streamlining its balance sheet hedge program by transitioning from a cumbersome, Excel-based system to an efficient treasury management system (TMS). Previously, managing the program was a time-consuming process, as it relied heavily on complex spreadsheets that were difficult to navigate and train others on. This approach not only consumed valuable resources but also exposed the company to considerable risk.
With the implementation of a new TMS, the organisation has successfully integrated all balance sheet exposures and hedges into a more centralised system, enabling more efficient gain and loss analysis and providing a clearer understanding of the net results of their hedging activities.
The transition to the TMS has resulted in significant improvements in operational efficiency, allowing a single team member to manage the program effectively while also facilitating the training of other personnel.
When asked about their advice for other professionals in the field, treasurers offered valuable insights. Sarah Alloy emphasised the importance of “having a seat at the table,” ensuring that treasury professionals are actively involved in discussions about strategic planning and risk management. Jacqueline Pagano recommended staying informed about market developments and being proactive in identifying and addressing risks. Rene Bustamante. Vice President & Assistant Treasurer at FedEx urged his peers to always be prepared to adapt and change, stating that “the best thing you can do is be flexible.”
As global markets continue to evolve, it is clear that effective foreign exchange risk management will remain a crucial component of corporate strategy.
The world’s largest and most influential treasury event will return this September in Barcelona. Join more than 2000 senior-level professionals representing over from more than 50 countries to exchange experiences, learn best practices and meet best-in-class financial and technological partners. This year we will explore the theme “Navigating a new world,” empowering treasurers to manage today’s new and complex challenges and optimise treasury for the new economic cycle. Find out more.