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Why You Need an Automated Budget Hedging Program
For example, a company with EUR as its functional currency may wish to protect its Hedging the budget: the automation imperative
The previous blogs on hedging the budget were devoted to:
- The reasons why CFOs and treasury managers may want to protect the budget rate of an individual campaign/budget period;
- The mistakes they often make as they implement the corresponding hedging programs to protect the budget rate.
- The best practices in protecting the FX budget rate, including combinations of hedging programs.
In this final blog of the series, we want to present the automation requirements of a well-run combination of hedging programs designed to systematically protect the budget rate from FX market fluctuations.
Hedging the budget: nowcasting and traceability
At first glance, a program to protect the FX budget rate used in pricing would not seem to require a high degree of automation. This perception can be misleading.
Time and again, experience shows that manual execution is a resource-intensive process that carries operational risks—especially when several currency pairs are involved, each with its particular degree of volatility and situation in terms of interest rate differentials.
When combining a static FX hedging program with a micro-hedging program for firm commitments —by far the most effective way to protect the budget rate—, three elements require an advanced degree of API-enabled automation:
. Nowcasting of FX exposure
. 24/7 markets monitoring
. End-to-end traceability
Nowcasting the FX exposure: automation requirements
As we saw in the previous blog, the combination of a static hedging program and a micro-hedging program for firm sales/purchase orders sets in motion a process of ‘nowcasting’. This occurs as the FX exposure is automatically adjusted when hedges are executed.
Achieving this, however, is easier said than done. On the one hand, the ‘static’ part of the program relies on forecasts that often sit on Excel spreadsheets. On the other hand, firm sales orders may originate from the company’s CRM or other system. This involves at least two different sources of exposure information, with different ‘owners’ within the firm.
These types of exposure are created with different frequencies. Most likely, they also involve a different level of granularity. In addition, care must be devoted to ensuring that, while new forecasts for revenues and expenditures override previously existing ones, firm orders accumulate as time passes by.
As the reader will surely realise, this calls for what we call, at Kantox, “system-agnostic” API connectivity.
ILLUSTRATION
24/7 market monitoring: automation requirements
Programs to protect the FX budget rate are market-driven, an important difference with time-driven layered hedging programs. The latter works ‘like a clock’ because the schedule of hedges is known in advance and has to be executed according to a predetermined calendar of trades.
The distinction between time-driven and market-driven FX hedging programs has implications in terms of the technology and automation requirements. While the stop-loss (SL) and take-profit (TP) orders that protect a worse-case-scenario FX rate can be manually set, the exposure should be managed in different partitions with a well-defined hierarchy.
campaign/budget rate on its GBP-denominated sales. With a EUR-GBP 0.8540 spot rate at budget definition, the treasury team sets the worst-case scenario used in pricing at 0.8796, a 3% markup.
Protecting this FX rate can be achieved by setting three different SL orders, each covering ⅓ of the forecasted exposure. To give the finance team some flexibility, these orders can be set at EUR-GBP 0.8884, 0.9796 and 0.8708, so that their average matches the worst-case scenario rate to protect.
More work is required in terms of the monitoring of firm commitments. As individual pieces of exposure accumulate into the positions that are likely to be hedged, the Weighted Average Exposure Rate (WAER) must be recalculated 24/7, with each piece coming in at a different currency rate. Clearly, this sort of task is ripe for automation.
Traceability: automation requirements
Further automation is required to track firm sales/purchase orders (hedged items) to the corresponding forecasted exposure that is hedged (hedging instruments). This makes it possible for finance teams to apply Hedge Accounting under IFRS 9 and US GAAP.
Hedge Accounting can be a time-consuming task that, when manually executed, requires skills in accounting and in the valuation of financial assets. Companies sometimes shy away from applying Hedge Accounting —and even from currency hedging altogether— due to the perceived costs in terms of documentation and compliance.
API-enabled traceability allows finance teams to easily perform all the work involved in compiling the required documentation. The same can be said for the task of using FX swaps to adjust the firm’s hedging position to the settlement of its underlying commercial exposure.
Given the role of traceability in accounting and swap execution, it comes as no surprise that a recent EACT Treasury Survey reveals treasurers’ preference —when it comes to treasury technology— for Data Analytics and APIs.
Hedging the budget meets technology
The practice of protecting the FX rate embedded in the pricing of a campaign/budget period is being redefined as we speak. It is no longer enough for companies to take a big hedge at the onset of a budget period and hope that their forecast accuracy will save the day—and the budget.
In terms of FX hedging programs, this requires treasury teams to:
- Effectively integrate static and micro-hedging FX hedging programs
- Use market-driven programs with 24/7 monitoring and perfect traceability
- Leverage the power of delaying hedge execution
Thanks to Currency Management Automation solutions, protecting the budget rate from FX fluctuation helps CFOs and treasurers systematically achieve their KPIs. This can be achieved independently of their degree of forecast accuracy—and of what happens in currency markets during the campaign.
