Rewriting hedging policies
Severe shocks should not unravel sound hedging policies, but an increasingly complex environment is prompting some treasurers to question their approach to risk management.
Just as the world tries to move on from the Covid-19 pandemic, new challenges are springing up for treasurers such as inflation which is currently at three decade highs in the US.
“We have more risks than we used to have,” said Michael Storup, a Treasurer at Inter IKEA Group, the multinational furniture retailer. For him, the pandemic is just another example of how the world has changed since 2016 with Brexit and the election of former US President Donald Trump. Speaking at the 2021 International Treasury Management Virtual Week, Storup explained that the focus for his team has expanded from economic and market issues to include geopolitics.
For instance, moves by western countries to repatriate supply chains from China for political reasons are helping stoke inflation adding to the disruptive impact of the Covid-19 pandemic.
“If you rewind 15 months back, most companies were concerned about deflation,” said Atul Garg, Assistant Treasurer at Campbell Soup Company, a US food business. “And a lot of companies were struggling with commodities (prices) crashing down and people were debating whether they should have a hedging programme or not.”
When Covid struck many commodity prices plunged with oil futures at one point slumping into negative territory due to oversupply. This placed airlines in a bind as their revenues were wiped out by population lockdowns to stop the spread of the pandemic. This left them with hedges without underlying offsetting inputs, namely jet fuel – their largest variable cost.
Finland’s national airline, Finnair, used a rolling hedging programme stretching out to 18 months for jet fuel and had to unwind them in chaotic markets when the pandemic arrived. Normally, Finnair tries to match fuel hedges as closely as possible with its network and fleet plan and then purchases the jet fuel near the time it is needed. But the pandemic: “was really an event that your risk management policy doesn’t foresee,” said Christine Rovelli, SVP Finance & Fleet Management at Finnair. Finnair is now reviewing its fuel hedging strategy.
Europe’s fastest growing airline Wizz Air also hedged before the pandemic struck, but had a rethink. “Back in June this year, we moved to a no hedge policy,” said Viktor Mura, Head of Treasury, Tax And Investor Relations at Wizz Air, adding that this applies to jet fuel as well. What enabled this change is the low cost carrier’s robust balance sheet and liquidity and relatively short booking window for flights. This gives the airline greater flexibility to adjust pricing and to absorb losses, Mura explained.
The post-pandemic surge in inflation has intensified the hedging debate at other consumer-focused companies. “Higher commodity prices, higher transport prices, higher energy prices, and the velocity of these moves in the last four or five months has put a lot of pressure on our input costs as a company,” said Storup, explaining that Inter IKEA Group hedges FX, but not commodities.
Though he believes some of these inflationary pressures are transitory, Storup is concerned about the impact of rising wages and whether that will become a long-term trend. “We’re not seeing wages go up that much yet,” he said, warning that so-called transitory periods can be very long lasting.
Contemplating those cost pressures, Mura said: “It’s more of a business risk than for the treasury.” He explained that it is a case of having the right people and business model to structurally hedge against inflation.
But there is also the Environmental, Social and Governance angle to consider. “I think initially there will be more inflationary pressure coming from the change to a sustainable way of doing business, eventually it will be disinflationary, but that’s going to take some time,” said Storup explaining that Inter IKEA Group is seeking environmentally friendly materials and transport.
Recent events have not undermined the case for sound hedging policies, but they reinforce that risk mitigation has limits. As was noted during the event, there is no such thing as a shock-proof hedging strategy.
“We do disaster recovery planning. We take that into account in our risk management policies, but it would be hard to think of another risk (like the pandemic) of this magnitude and stop-start nature that we could specifically plan for,” said Finnair’s Rovelli.
Campbell Soup had a relatively good crisis as food demand remained unabated. “Fortunately for us we did not have a severe negative impact. So I don’t think our forecasts would have changed that much even during the peak of Covid. There were swings, but they were manageable,” said Garg.
He explained that a successful hedging programme should not be nullified by price volatility – even if tweaks need to be made, say due to changes in market correlations. One solution proposed by many banks is to switch from using forwards to options, which allow flexibility in very uncertain business environments.
However, for Storup the pandemic reinforced Inter IKEA Group’s cautious approach to using options for hedging purposes. “Keep it simple, keep it as vanilla as possible,” he advised. “Don’t go into all these fancy structures that the banks want to sell us so that when something like Covid hits you are not protected in the way you thought you were.”
However, Garg acknowledged there can be cases for reviewing hedging policies citing airlines as an example. “If there is a structural change, not having an underlying exposure, obviously you have to review the whole programme holistically,” he said.