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.
Does it make sense to neatly separate the task of managing FX risk from cash and liquidity management tasks, as most treasury surveys do? We remain unconvinced.
As this episode shows, technology is bridging the gap between FX risk management and cash and liquidity management, to the point of making them virtually inseparable.
There are at least four areas where API-based connectivity and Currency Management Automation come together as they help treasurers manage cash flow and liquidity:
As the treasury team updates its 30, 60 and 90-day cash flow forecasts, the FX element coming from commercial transactions introduces an added element of instability. But where is the relevant data? Is it in managers' heads? In the ERP? In Excel files?
More challenges: a rule for aggregating exposures is needed. Finally: what about forward points management? CHF trades at a forward premium to USD and EUR, but BRL does so at a deep discount. This requires different approaches.
There is a way out of these practical dilemmas. Micro-hedging programs rely on API connectivity to capture the exposure from any company system. They allow finance teams to remove any FX-related uncertainty in cash flow forecasts.
Just to give an example: you may hedge 80% of your firm sales/purchase orders and automatically move to 100% as soon as the accounts payable / receivable are recognised on the balance sheet. That’s perfectly doable.
A currency swap is equivalent to a package of forward contracts. On the one hand, an amount of currency is bought or sold against another currency with a given value date. On the other hand, the reverse trade takes place, but with a different value date.
FX swaps are used in a variety of contexts by companies, asset managers and banks—and even central banks. For corporations, they are especially well suited to manage the currency mismatch between debt and assets—when a firm buys assets that throw cash flows in a currency that is different from the currency of the debt that was raised to buy those assets.
Here we focus on how FX swaps are used to adjust the firm’s hedging position to the settlement of the underlying commercial transactions. We call it the “Cash Flow Moment” in FXRM.
Ensuring a perfect match between the settlement of commercial transactions and the corresponding FX hedges is next to impossible. Just to mention an example: J Sainsbury’s, the UK-based retailer has exposure to currency risk that arises from short-term timing differences between maturing hedges and the underlying supplier payments.
To bridge the gap between these positions, swapping is necessary. Swaps allow treasury teams to:
Consider the following ‘early draw’ example. Company A has an open forward position to buy $1,000,000 against EUR at a forward rate of EUR-USD 1.1100. The position was taken several months before to hedge a forecasted commercial exposure.
Company A now faces a payment of $100,000 related to that exposure. Swapping is therefore required to ‘draw’ on that forward position. There are two ‘legs’ this transaction:
Thanks to this transaction, the treasury team not only obtains the required amount of dollars on the spot — its forward position at the original value date is also automatically adjusted. Quite naturally, FX gains/losses will be involved, as the exchange rate will have shifted.
Note that treasurers need to assess the forward points impact of that transaction. On the original forward transaction, forward points were said to be favourable as the company buys a currency (USD) that trades at a forward discount to its own (EUR). But the reverse happens with the swap.
Treasurers know it too well: swapping is complex and resource-intensive. Day in, day out, we encounter situations that show the stress members of corporate treasury teams find themselves in as they execute the indispensable FX swap transactions:
Faced with an array of costs and risks, beleaguered members of the treasury teams can turn to API connectivity and swap automation to solve the many operational and cost-related challenges related to swap execution.
As Ignacio Recalt, Treasury SaaS and Payments Product Owner at Kantox says:
“Swap automation frees up resources and removes operational and other risks. Whether they need to anticipate or roll over FX forwards linked to payments/collections, treasurers can execute the process in one click.” — Ignacio Recalt
With complete visibility and control, the finance team obtains:
When Canadian retailer Dollarama tells investors that it imports directly from overseas suppliers in their own currencies, it emphasises what management calls a strategic business decision designed to gain a competitive advantage.
And it adds: this is a way to minimise markups applied by suppliers on the contracting side. Note that the stock price of Dollarama is up by 50% this year.
The strategic orientation to use more currencies in commercial operations also produces a number of liquidity management and working capital-related benefits. In this age of Trade Policy Uncertainty, these advantages seem compelling enough:
Many successful Scandinavian companies use a centralised Treasury setup where the primary goal is to ensure liquidity at all times by procuring funding on a centralised basis and actively managing foreign exchange risks and interest rate risks.
Here, again, we can report good news from the treasury technology front. Scalable tools that were once exclusive to large enterprises make it possible for any firm with foreign subsidiaries to implement solutions like Kantox In-House FX.
The main benefits include:
By introducing a neat distinction between tasks, most treasury surveys enumerate sets of priorities that are seemingly separated from each other. Courtesy of various crises, cash and liquidity management issues have consistently claimed a top position in most rankings.
But are these treasury surveys taking the right approach? This blog shows that a clear separation of treasury tasks does not correspond to the real world. The touchpoints between FX risk management and cash and liquidity management are too numerous and too meaningful to ignore.
It is only when we abandon the siloed approach between tasks that we realise how much technology is bridging the gap between FX risk management and cash and liquidity management, to the point of making them virtually inseparable.
If you are struggling with the process of swap execution and all the manual tasks that it involves, take a look at our comprehensive report Optimising Cash & FX Risk Management or 👉 send us your data and FX challenges here.
