Cash Management and FX Risk Management

“Cash is king” is a well-known corporate finance mantra. It underlines the importance that companies assign to cash management—the daily process of collecting, handling, and using a company's most liquid asset.

For firms that hedge their currency risk, cash management is complicated by the need to adjust hedging positions to the settlement of the underlying commercial transactions. When the payment dates of hedged FX-denominated cash flows change frequently, treasurers can use currency swaps. 

When manually executed, this is a painstaking and time-consuming process that can quickly become a source of operational risk. It therefore stretches the resources of treasury teams, especially in small and medium sized businesses.

Advances in FX automation are bridging the gap between cash management and FX risk management. Swap automation, coupled with the emergence of new standards for payments and financial messaging, is greatly simplifying most FX-related cash management tasks. 

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Why Cash and FX Risk Management are Connected

In many industries, a myriad of factors, both internal and external, can make the delivery of goods sold uncertain. As a result, corporate treasurers frequently adjust their hedging positions in response to changes in the settlement of the underlying commercial transactions.

A European furniture company, for example, may be notified by one of its USD-based suppliers that some deliveries, originally scheduled for a future date, will instead take place immediately. The firm then needs to do two things. First, it must obtain USD cash to pay for the goods. Second, it must adjust the original hedging position to avoid over-hedging. 

In the opposite situation, when a delivery is postponed, the value date of the corresponding hedge must be rolled forward to the new expected value date. Both adjustments involve currency swaps. Here’s how Airbus describes the process: 

"In situations where the payment dates for hedged firmly committed cash flows are not fixed and subject to potentially significant delays, the Company may use rollover strategies, usually involving foreign exchange swaps." — Airbus

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Bridging the Gap Between FX and Cash Management

Ensuring a perfect match between the settlement of commercial transactions and the corresponding FX hedges is next to impossible. To bridge the gap between these positions, swaps are necessary. They are the ‘cash flow moment’ in FX risk management.

Currency swaps allows treasury teams to:

• Draw early draws on existing forwards
• Roll forward existing positions

The illustration below shows a 'draw' transaction. Because 10% of a planned $ 1 million delivery is expected to take place immediately, the treasury team must make an immediate cash payment of $100,000. It must also adjust the underlying forward position.

With the ‘near leg’ of the swap, the company buys the required $100,000 in the spot market. At the same time, the ‘far leg’ of the same swap avoids over-hedging by selling the corresponding amount at the original value date.

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The process just described involves a number of cash management related exertions, as payments and funds transfers to liquidity providers need to be executed.

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Swap Automation to the Rescue

Swapping is a complex and resource-intensive undertaking that carries operational risks arising from manual execution. By freeing up resources and reducing those risks, swap automation provides relief.

Whether they draw early on or roll FX forwards linked to payments and collections, treasurers can execute the process in one click. With complete visibility and control, finance teams gain:

• Swift integration with ISO20022
• Traceability between swap legs and the underlying forwards
• Granularity in terms of FX gains and losses and forward points
• IBAN and BIC setups integrated with the ERP and TMS

API-based ‘chains’ that link swaps to their corresponding forward positions allow treasurers to see everything that happens to a position. For example, if they have rolled forward more than once, the full history is traceable in the chain.

Created by Kantox, the chain concept provides a structured way to group and track all modifications to an original hedge, ensuring transparency and automation in cash and risk management workflows.

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New Standards for Payments and Financial Messaging

A corporate treasurer executes trades on a given currency pair —say, EUR-USD— with a single bank. To adjust the hedging position to the settlement of the underlying commercial exposure, they always execute FX swaps with that bank.

The treasurer thus avoids the hassle of moving funds between banks. But there is a catch: this procedure may deprive the company of the chance to take advantage of the best-price execution functionality of FX platforms. To steer clear of the extra cash management workload, the treasurer accepts higher trading costs. 

With Pain.001, the ISO 20022 XML message standard set to replace the current MT101 “Request for Transfer” standard, the process is automated. Say the company executes a forward with Bank B because it offers the most attractive FX rate.

On the value date of the forward, Bank B holds no USD from the company. With either pain.001 or its predecessor, Bank A transfers the USD to Bank B, allowing it to settle the forward and credit the corresponding EUR amount in the company’s bank account.

“Without any extra cash management effort to move money between banks, the treasury team profits from the best-price execution functionalities that come with corporate FX platforms” — Niklas Bölt, Kantox Sales Team Manager DACH

Best-price execution of forwards, swaps and spots is therefore possible without worrying about where money will be settled. This raises the question: is your team letting cash management issues get in the way of measurable cost efficiency?

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