CurrencyCast is a treasury podcast series from currency management experts. In each episode, we look at the pressing foreign exchange (FX) risk issues facing treasurers and CFOs today and help them identify the potential gaps in their FX risk management strategy.
Are you struggling to handle the P&L impact of FX-denominated order cancellations? Let's look at how you can effectively manage order cancellations in currency management and understand the advantages of automation to reduce the negative impact on your profitability.Whether you're a CFO or treasurer, you need to understand the cost of cancellations and how automated currency hedging programs can set you apart from your competitors. In this article, we will take a deep dive into the best way to handle FX-related order cancellations with key takeaways from this CurrencyCast episode. So let's dive in!
It is no secret that the wave of cancellations following COVID-19-imposed travel restrictions was a nightmare for airlines, hotel chains and tour operators alike. Largely due to cancellations, air traffic plummeted in 2021 in Europe to less than half pre-pandemic levels. The problem is not confined to the Travel industry. Studies show that about $430 billion worth of goods is returned every year in the United States alone.
In the Travel world, dynamic prices are the norm. OTAs, Bed banks, Hotel chains, DMCs and others frequently update their FX-denominated prices, and their cash flows are at risk from the moment of the bookings till settlement. For this reason, most Travel distribution firms consider bookings as ‘firm commitments’ and key FX exposure items.This is where cancellations kick in. A cancelled FX-denominated booking diminishes the exposure to currency risk if the corresponding hedge has not been executed, or if an already executed trade is closed out at the same FX rate. Otherwise, there would be a situation of over-hedging.
Given the amount of resources involved, companies are scared by the ghost of cancellations. But, are all those fears warranted? Not when it comes to currency management. Currency management consists of three phases: pre-trade, trade, and post-trade. Cancellations are an important element in the pre-trade phase of the FX workflow when the exposure to currency risk is collected and processed. Manually adjusting hundreds or even thousands of individual pieces of exposure to the corresponding hedges can be an impossibly complicated task.That's where currency management automation solutions come to play. They provide companies with the tools to minimize the P&L impact of order cancellations, let's see how that's done.
Currency management automation provides two lines of defence. The first line of defence is to include, as part of the business rules, defining the process of automation of an automatic cancellation rate.For example, if managers set a 10% cancellation rate, the software solution will hedge 90% of the corresponding exposure. As time goes by and more information becomes available, that particular cancellation rate can be refined and adjusted.The second line of defence is provided by what we call negative entries, which is a more powerful way of dealing with cancellations. An entry is an individual piece of exposure to currency risk. Currency managers define rules for the aggregation of such pieces of exposure, including a rule for setting negative entries from their own ERP in the event of order cancellations.API-transmitted negative entries automatically cancel the corresponding FX exposure. When many transactions are involved, new entries are constantly generated with the same value date and the same currency pair, and the solution then matches hedges and transactions. Here, as in many other aspects of FX management, end-to-end traceability plays a key role.
Automated currency hedging programs treat order cancellations as an integral part of the pre-trade phase of the workflow. The ability to quickly process them can set you apart from your competitors. If you aim to seriously tackle the problem while relieving the financing from resource-intensive manual tasks, Currency Management Automation is your starting point.By using the right tools and following the best practices, currency managers can minimize the impact of cancellations and maintain control over their currency risk exposure.
