CFO Perspectives: How to set a currency hedging strategy

How should a CFO set their currency hedging strategy, to protect cash flows or to minimise P&L impact? In the fourth edition of CFO Perspectives, we’ll explore how senior finance professionals can choose the right path when it comes to hedging.

According to a recent HSBC report, the objectives of currency hedging are pretty extensive. While three-quarters of surveyed participants mention forecasted cash flows as an FX risk that their company hedges, 61% cite balance sheet items as the risk they hedge. Other participants say minimising the impact on consolidated earnings is one of their FX hedging objectives and KPIs.The debate about whether to hedge cash flows or earnings —by removing the impact of accounting FX gains and losses— is as old as currency hedging itself. The two sides have powerful arguments in their favour.

Cash flow hedging vs balance sheet hedging

What's the correct approach?

The debate will likely never be settled entirely. No single approach for currency risk management is definitively better than another. Different opinions may reflect the type of business activity, the preferences of investors and even managers’ own biases.The key step for any CFO looking to establish or revamp their business’s currency hedging program is to clarify what the firm is trying to achieve. Only with enough clarity on this matter can the dangers of ad hoc or unsystematic hedging be avoided. So, where does that leave us? This blog brings some welcome news to beleaguered CFOs as they take sides. While nothing replaces clarity regarding the key objectives of currency management, technology now makes it possible for risk managers to:

1. Use a single set of software solutions to run cash flow and balance sheet FX hedging programs
2. Automate the time-consuming and resource-intensive process of implementing Hedge Accounting

This is big news indeed!

Practical steps on the journey to the FX hedging decision

While a certain amount of debate and discussion is unavoidable when deciding the goals of a firm’s FX hedging program, a number of practical steps can be followed to determine what should be hedged.These steps share a central concern about protecting and enhancing the firm’s operating profit margins by giving particular importance to the pricing characteristics of each business division.These steps include:

1. Steer clear of ad hoc or unsystematic hedging. This is a path to nowhere and should always be avoided.
2. Set the goals of your FX strategy, such as defending a campaign or budget rate, achieving a smooth hedged rate over time, hedging transaction exposure, or removing the impact of accounting FX gains and losses.
3. Based on these goals, define the best hedging program while imagining that infinite resources can be deployed. By doing so, CFOs can squarely focus on their FX goals.
4. Consider using Currency Management Automation to seamlessly execute all the steps of your program, breaking internal silos and ensuring connectivity with your own company systems (ERP, TMS).
5. Only then ‘prune’ the strategy and adjust it to the available resources, while measuring the impact —in terms of risk, costs and growth— of this adjustment.
6. Use technology to automate the process of compiling the required documentation for Hedge Accounting.

In other words: to set a currency hedging strategy you need to do away with outdated constraints. Technology is putting to rest the traditional view of currency management as a resource-intensive activity. So the message is: give priority to your FX goals, not to the resources currently at hand.

Read the third edition of our CFO Perspectives series, 5 ways CFOs can increase the efficiency of treasury operations.