Pharmaceutical Industry: Managing FX in Times of Uncertainty
The Pharmaceutical industry has faced a number of shocks in recent months, including sharp swings in production in India and China and global supply chain distortions. Meanwhile, broad-based government intervention has resulted in a race to produce treatments and vaccines to face the threats posed by the Covid-19 pandemic.
Volatility in financial markets, including foreign exchange markets, is adding more complexity to the outlook. In a special Kantox webinar, we review pharmaceutical companies’ strategies to cope with currency risk in a world where forecasts are less reliable and the need for flexibility becomes ever more pressing. The webinar concludes with a set of ‘best practices’ for FX hedging.
The governance of currency risk management
Many pharmaceutical companies have a centralised approach to currency risk management. This enables them to capitalise on netting. It also makes it easier to visualise the amount of FX exposure at group level, while allowing subsidiaries to concentrate on their own specific business operations. The downside is that a high number of transactions and currencies makes management very difficult.
In a more decentralised approach, in which subsidiaries manage their own specific currency risk, traceability issues inevitably arise as risk is dispersed across many entities. When these subsidiaries sell in foreign markets in the functional currency of the group, exchange rate risk is (apparently) taken out of the equation. However, this is a misleading approach. As experience has recently shown, a client might choose to delay payment in the event of a major local currency depreciation. In this scenario, currency risk can quickly mutate into liquidity and credit risk.
The nature of currency risk in the pharma world
The chronology of a typical sales transaction for a pharma exporter shows the triple nature of currency risk:
- Accounting gains and losses between the moment of the invoice and settlement ;
- Transaction risk between the firm commitment and settlement;
- Budget risk from the moment pricing is set.
The time span between each of these moments, often quite considerable in the pharmaceutical industry, creates currency risk.
For each company, the optimal way to deal with the different aspects of currency risk depends on a set of parameters that include: the firm’s pricing dynamics (is an FX rate systematically part of pricing parameters?); the firm’s competitive position and the local and cost structure of its main competitors; the situation in terms of forward points, and —last but not least— the firm’s degree of forecast accuracy.
The downside of current FX management practices
While the nature of foreign currency risk is broadly understood in the pharmaceutical industry, many firms are hampered in their ability to adequately manage risk. This is largely due to the lack of adequate resources and to the prevalence of outdated, manual processes whose weakness has been exposed as the Covid-19 crisis unfolded.
In the immediate aftermath of the crisis, when urgent financial issues like financing and re-budgeting were given priority, remote work could hardly cope with the task of managing foreign exchange risk. The problem was compounded by the inefficiencies stemming from time-consuming and error-prone manual data gathering.
This is precisely where FX automation comes in. In a world where forecasts are less reliable and the need for flexibility becomes ever more pressing, risk managers can cost-effectively automate processes that allow them to create tailor-made hedging programs to simultaneously tackle all aspects of currency risk: budget risk, transaction risk and accounting risk.
If you’d like to find out more about the best currency hedging practices for the pharmaceutical industry, check out our webinar on this topic: