00;00;00;05 - 00;00;28;02
Unknown
How do global companies tackle currency management in this age of heightened uncertainty? And how does the carry trade impact currency hedging? Welcome to CurrencyCast.! My name is Agustin Mackinlay, I’m the Senior Financial Writer at Kantox and your host. In this episode, we have the pleasure to welcome Daisy Andrew, Interest Rate and FX Corporate Sales at BNP Paribas in London.
00;00;28;05 - 00;00;54;22
Unknown
Daisy, a very warm welcome to you and thank you for joining us in this episode of CurrencyCast. Thank you for having me. Can you introduce yourself to our audience? Of course. So my name is Daisy Andrew. I work within the IRFX Corporate Sales team here at BNP Paribas. Essentially, this means that I cover large and mid-cap corporates UK specifically supporting both our foreign exchange and interest rate hedging requirements.
00;00;54;24 - 00;01;37;09
Unknown
As a team, we're sector agnostic, so I work within a range of industries, each with slightly different hedging requirements and needs, which keeps things interesting for me. I've been in this role for about two years, but I've actually been at the bank for over eight years. I joined straight from university, so prior to joining sales I spent five and a half years on the trading side, both in FX spot trading and FX swap trading, which I personally feel allows me to have a slightly more in-depth kind of take on the hedging process that corporates and clients across the board should be looking at.
00;01;37;12 - 00;02;14;05
Unknown
All right, then we're going to take advantage of your expertise in this area, of course, during this conversation. Well, let's start straight with the foreign exchange risk management topic. And my first question is about the goals or the primary objectives of CFOs and treasurers as they approach you at the interest rate and foreign exchange desk there in London. Is their main goal to remove, for example, the accounting impact of foreign exchange gains or losses from the P&L?
00;02;14;05 - 00;02;44;09
Unknown
Is it to lower the variability of cash flows over time? Tell us about how CFOs and treasurers express their management goals. Sure. So in theory, yes. The goal in most cases is to minimise the impact of FX market fluctuations. But depending on the currency exposure, the investment structure of the corporate, the industry, etc., the KPIs can vary quite significantly.
00;02;44;11 - 00;03;13;19
Unknown
Company to company. So in order to manage this, most companies have a fairly comprehensive and robust hedging policy, which they stick to quite diligently. I think this is the main issue kind of arising from this, or one of the main issues that we see, is often these hedging policies are quite rigid and they lack the flexibility to allow Treasury teams to update and change the policy and make sure that it's fit for purpose.
00;03;13;22 - 00;03;40;02
Unknown
So as the market evolves, we do see the kind of hedging needs change. For example, what someone did five-ten years ago is is kind of very different to what someone should be doing now given how the market has changed. For example, if you had a very specific fixed float mix, or hedging tenor choice or product suite ten years ago, there's a good chance that they're not really working for you in the exact same way now.
00;03;40;04 - 00;04;03;16
Unknown
So I think one of the things that I would consider for corporates is to just keep in mind a level of flexibility in your policy. So whatever it is you're trying to do, and as I said, it's generally minimising the impact of FX market moves. Just make sure that your policy allows you to adjust the way that you're hedging, to make sure that you are actually doing this year on year.
00;04;03;16 - 00;04;36;04
Unknown
Yeah, right. And also, I think we could argue that changes in and say in the business model and even in technology might affect the well to the goals and how you would go about hedging. So that's why you require that flexibility. That's a really interesting point. Now there's a lot of academic papers on papers from central banks discussing the impact of foreign exchange changes in pricing policies of companies.
00;04;36;04 - 00;05;06;25
Unknown
I've seen recently a paper by the Swedish Central Bank saying that arguing that changes, for example, in the Swedish krona to the dollar do not really impact pricing policies at Swedish companies because they see it as a sort of a flight to safety and they are afraid of adjusting their prices if demand is very low. So that's a topic that is obviously very interesting to us.
00;05;06;27 - 00;05;47;08
Unknown
Describe Daisy for us, please the main hedging programs applied by companies in relation to their pricing policies. Sure. So I think first, it's useful to think about the different types of exposures that corporates have. So for the most part we can split FX exposures into two groups. You have transaction risks, which are the risk associated with making financial transactions between two different jurisdictions with different currencies. And the potential profit or loss resulting from the moves in exchange rate between the kind of time at which this exposure is built to the settlement time.
00;05;47;10 - 00;06;13;22
Unknown
And then we have translation risks which are essentially associated with the balance sheet reporting of foreign currency assets and the FX exposure resulting from reporting them in your balance sheet in the functional currency. So I think oftentimes when we look at FX hedging, the vast majority of effective hedging that we do is the transaction hedging, and this can be a split into two groups again.
00;06;13;22 - 00;06;54;20
Unknown
So we have booked exposure, which pretty much every corporate hedges, that is FX exposure that you have on the book at the time. And then forecasted exposure. And I know you work at Kantox and a lot of what you do will be working with how to automate and improve this forecasted exposure hedging. So the way that forecasted exposure is hedged varies quite a lot company to company. And this really depends on largely the confidence in their forecasts, to be honest with you, but also their capacity to hedge, the ability to absorb market movements and the kind of list goes on.
00;06;54;22 - 00;07;23;28
Unknown
But often clients use a layered approach and by this I mean they might do 100% of hedging between zero and three months, 75% between three and six months and so on. But what we do see is some patterns between different industries. So if you look at pharmaceuticals, for example, they generally hedge quite short-dated. So 3 to 6 months, given the fact that they have wide margins and quite a good ability to pass costs through to consumers.
00;07;24;00 - 00;07;47;24
Unknown
Retailers, on the other hand, use a very layered approach, 6 to 18 months generally. And often, because what you don't want is one supermarket having to increase their pricing because they didn't do the forecasts, the forecast hedging well, whilst another one did and therefore doesn't have to increase pricing and those tight margins mean that consumers are going to pick one supermarket over another.
00;07;47;27 - 00;08;22;06
Unknown
And then if we look at industrials and automakers, they often hedge much further out. So 2 to 5 years and again, they have very tight margins, but also a really good ability to forecast their cost base going forward. So it really depends on business model. But again, as I've kind of alluded to before, what I think is important is that Treasury isn't seen as a restrictive function, but it's commercially supportive, i.e. if you need dynamic pricing in one area of the business and stable pricing in another, you have the ability to use that and do that.
00;08;22;06 - 00;08;47;01
Unknown
So in a good example would be a kind of holiday company that offers flights through the airline and also holiday bookings. You want the stable pricing for the holiday booking. So the hotels don't vary day to day, but you need the dynamic pricing in your fuel cost hedging. So it's really about tailoring the way that you hedge and your hedging policy to make sure that it is being commercially supportive.
00;08;47;03 - 00;09;18;19
Unknown
Yes, absolutely. We agree completely there. Now, you discussed, well you mentioned the topic of forecast accuracy. Right. And so let's dig a little bit deeper into that here. Again, there's well, it was obviously a big topic a few years ago with COVID and associated problems. There. But there are all the time new developments like nowcasting or even the use of artificial intelligence.
00;09;18;19 - 00;09;54;25
Unknown
I was on present at the OECD summit in Brussels back in June and the audience was mesmerised by the presentation by ASML, the Dutch semiconductor company saying that the use of an artificial intelligence tool allowed them to improve on their forecast accuracy. So broadly speaking, how do you approach that topic? The topic of long-term cash flow forecast accuracy?
00;09;54;28 - 00;10;23;05
Unknown
Yeah. So in my experience is it's a huge challenge faced by nearly all corporates to be honest. And certainly one of the key barriers to to kind of moving into automation when it comes to the FX hedging. I very often find myself wishing that we had created a partnership like we have with Kantox, with a forecasting startup, because I think that would be a great thing to sell.
00;10;23;07 - 00;10;51;04
Unknown
But is clearly there's a kind of hold in the market and most corporates, do you find it quite challenging. What I will say is generally this lack of ability to accurately forecast their FX exposures means that corporates do seem to avoid wanting to heavily automate their hedging program. And it mean largely, I think it's because they want to have this manual oversight.
00;10;51;04 - 00;11;21;00
Unknown
You know, they want to be able to say, hold on, every month we're left-hand side euro-dollar but this price, this exposure is right-hand side. Why is that or, you know, this seems very outsized versus the usual. But I do feel that this is a little bit shortsighted because with the right automation and certainly conversations that we had with can talks with other clients, we can build in these kind of red flag checkers into the automation.
00;11;21;03 - 00;11;46;28
Unknown
So maybe instead of a person going through manually checking this every week or month, you have a robot doing it and that's much better. You know, you don't have that added element of human error. You have these very strict rules where if the notional is above X or the direction is different to the last three months or whatever, however you want to build it, we can go through and check them every single time in the exact same way.
00;11;47;05 - 00;12;07;23
Unknown
Like I say, without that added element of human error and doing this level of automation and helping that should in theory, free up time to be able to work on forecasting. And make sure that your model is being improved kind of month on month rather than wasting time manually checking forecasts each time you're looking to do some hedging.
00;12;07;25 - 00;12;34;20
Unknown
Yes, absolutely. We like to say at Kantox that if you combine say a micro hedging program for firm sales orders with a program that hedges the budgeted exposure, you have a sort of a nowcasting tool. And we would like just to downplay a little bit this concerns that that CFOs and treasurers sometimes express when it comes to forecast accuracy.
00;12;34;23 - 00;13;06;22
Unknown
They say, let's move to the topic of the carry trade and I know you were correct me if I'm wrong, but active in FX trading also at BNP Paribas before. And you remember, of course, what happened in early August 2024. For now, it turns out that I was literally traveling up and down the Basque country, both on the French side and on the Spanish side, as I read the news there.
00;13;06;22 - 00;13;36;19
Unknown
And I also well, happened to come across a paper by the BIS, the Bank for International Settlements. And they wanted to put numbers on the carry trade, especially on the size of that apparently huge short position in Japanese yen. There is no way to really do that except to take what happens in futures markets where you have observable
00;13;36;20 - 00;14;13;11
Unknown
figures for those positions and extrapolate them to the over-the-counter markets. And I think they came across with a number of like $250 billion equivalent in insured yen positions. Tell us, Daisy, how does the carry trade work? Sure. So it's actually something interesting. When I joined the corporate desk, I had to kind of rethink the way that I looks at carry, because I do think the corporates and investors do see it slightly differently.
00;14;13;13 - 00;14;39;26
Unknown
So using the yen carry trade as an example, as you've already mentioned, the way that an investor would see it is they would borrow yen to fund buying a higher yielding product. For example, mex-mex. So you could borrow yen a near 0% and then sell that to buy MXN and you can buy Mexican bonds or whatever you really wanted.
00;14;39;26 - 00;15;03;13
Unknown
Let's say bonds, for example, yielding around 10%. If you're borrowing zero and you're buying something at ten, you're making 10%, which is amazing. The process of doing this requires you to sell yen and buy mex. So essentially right hand side, mex-yen, this idea is great and over time you can slowly build this 10% year or whatever the difference is.
00;15;03;16 - 00;15;26;20
Unknown
And that's fab if your currency doesn't move because you're just earning this yield and you're not getting the kind of negative effects of currency movements, or if you are in a risk environment, for example, it might benefit you. But what we saw of a summer was this much loved carry trade. For example, mex-yen starting to move in a kind of negative way.
00;15;26;20 - 00;16;10;10
Unknown
So we saw yen strengthen and a bit of risk off and mex-yen over the course of about a month in summer moved over 20%. So very quickly you've completely wiped away your 10% carry benefit and you're now 10% of the money in the space of a month. So obviously what this resulted in was a mass kind of exodus of all carry trades. And I remember we saw dollar-yen falling around 12 and a half percent over the course of that same month, just as everyone in the market, not everyone but a lot of people in the market who had these yen carry trades were just forced to buy back their yen.
00;16;10;10 - 00;16;37;25
Unknown
And it becomes a bit of a snowball FX, where it just builds and builds and builds. And and as more people buy yen, more people with the carry trade come out of the money and they are forced to step out as well. So now I can say bit of a snowball effect. Not a very nice moment for many junior traders whose managers had gone on their summer holidays, but an interesting moment regardless.
00;16;37;27 - 00;17;18;16
Unknown
Well, absolutely. And really great explanation there. Daisy, I have two more questions here regarding the carry trade, but let's start with this one. How could or what techniques can be used in foreign exchange corporate risk management to mitigate the impact of the, say for example, when you sell in a high discount or, you know, high forward discount currency or you buy in a forward premium currency, what are the main techniques that you can advise corporates to use? Carry is
00;17;18;16 - 00;17;41;25
Unknown
always a bit of a difficult topic for corporates and sometimes the market just isn't working in their favour. So we as a team do have a kind of suite of ways in which we can help the mitigate negative carry costs. So there are a few things that corporates can consider. One is just incorporating some optionality into the hedging portfolio.
00;17;41;27 - 00;18;07;06
Unknown
We've back tested a range of different structures, and note that in global environments and I know it doesn't feel like it, but we are still in a low exposed environment. Some strategies such as say, automated rolling collars have proven to work very well and so for corporates who do have the flexibility of incorporating some optionality, it's definitely something to consider.
00;18;07;09 - 00;18;36;07
Unknown
Another alternative and probably much more in line with Kantox is really just to hold off hedging when carry costs are high and then incorporate a range of limit and stop loss orders to ensure that the market doesn't run away too much from you. So I've had a few conversations with corporates and Kantox and it's something that they can do incorporate this these kind of limit orders into the automated hedging process and just kind of hold off from hedging currencies with high carry costs.
00;18;36;09 - 00;19;00;06
Unknown
So we did some back testing or Kantox did some back testing. And you can use a range of max loss scenarios depending on your risk appetite. So maybe you're willing to lose one or 2% a month because that's how it works with the with the carrier, you're already going to be paying, say, half a percent. You're willing to to risk another half a percent or however you deem fit.
00;19;00;09 - 00;19;34;04
Unknown
And the backtesting does show that for many currencies this proves beneficial versus just hedging day one. So it's definitely something to consider. Absolutely. We're very big fans of using automated conditional orders there to delay hedge execution in the face of unfavourable forwards. And by the way, it gives Treasurers time also to, coming back to what you said earlier, to update their forecasts in some setups, could even be beneficial from the point of view of collateral management.
00;19;34;06 - 00;20;08;15
Unknown
And why not, you might uncover netting opportunities, right, by delaying hedge execution. Now let's come to the last question on the carry trade, and it has perhaps to do a little bit with our own position, But I would really like to have your views on that. What are the lessons, if any, on that episode of the carry trade again, early August 2024 for corporate FX managers?
00;20;08;18 - 00;20;35;19
Unknown
Our position is mostly keep calm and automate, but why would you say. Yeah, so I guess to be honest with you, most corporates kind of are of the same view. The volatility that we saw over summer, especially with the carry washout, it felt really hectic for say me or the traders sitting in the seat. But in reality, as I already mentioned, those do remain relatively low overall.
00;20;35;21 - 00;20;58;10
Unknown
And given the last few years, well, the last five or so years, I think we're all pretty used to quite punchy moves in the market. Chatting to corporates, I think the vast majority didn't see the moves as any reason to deviate from the hedging policy. A few saw opportunities to restructure some trades, add or remove optionality, build on carry trades.
00;20;58;13 - 00;21;26;25
Unknown
But like I say, the vast majority were kind of unfazed. Right? I think honestly, if you look over the last five years, the major events where we saw people actively changing the way that they did things were the pandemic and also Russia. So basically times where we saw huge mark-to-market swings or exposures just ceasing to exist and them having to try and manage this in incredibly challenging liquidity conditions.
00;21;26;28 - 00;21;51;13
Unknown
Annoyingly, I wasn't on the sales test, but I think it was maybe more interesting on the trading side because I joined at a historically low rate global environment back in 2016 and I'd never really seen things move more than a few basis points a day, and that was when something was going crazy. So when COVID hit, we saw these massive moves.
00;21;51;13 - 00;22;22;05
Unknown
And I just think most corporates and investors just really had their hands forced and they had to act quickly and be assertive with the way that they did things. But I think the lessons we learned from that and the lessons we learned from summer is just again, remain super nimble, very flexible during volatile periods and not require these crazy market events, such as COVID or Russia, to trigger you to update your trading pattern.
00;22;22;07 - 00;22;50;17
Unknown
Just be kind of versatile where possible. And I guess if anything, it might be an interesting time to consider automation because the last five years of data has almost already been stress test. So you know, if you are incorporating five years worth of data into your hedging policy and the automation, well the automation that uses that hedging policy, in a way it's been stressed test.
00;22;50;17 - 00;23;12;16
Unknown
So you know that it's already gone through the ups and downs and it should prepare that model better for any kind of super volatile period to come up. Right. Right. We're also very huge fans of back testing all of the models all the time. And as you correctly point out, there's lots of data to tell.
00;23;12;16 - 00;23;57;23
Unknown
Daisy, I came across recently with a paper from the Bank of England and it goes back a little bit to the huge moves in markets that we saw in cable mostly right. In, of course, in 2016, but also in September 2022. And in that paper, there was the rather surprising conclusion that lots of UK firms, given what had happened to through to Sterling were starting to invoice directly in US dollars, do you see that really happening to a significant extent?
00;23;57;25 - 00;24;33;15
Unknown
And how would that affect corporate hedging? Yeah. So we did see some dollar invoicing and I guess to an extent it makes sense because generally dollar is seen as a little bit more of a stable, safer currency than the pound, especially post Brexit and the like. But I think more so than dollar invoicing, we're seeing corporates shifting away from invoicing in majors, i.e. euro, sterling, and dollar to invoicing in local currency as and where possible.
00;24;33;20 - 00;25;00;09
Unknown
So this allows Treasuries to take control of that currency risk and bring it in-house. I see if you think of the way that they're invoicing, if they're coming in, if they're invoicing local currencies in dollars or sterling, they're paying possibly quite hefty exchange rates without really noticing. Often this is because corporates don't want to have to manage a huge number of currencies.
00;25;00;10 - 00;25;20;16
Unknown
They're you know, bringing supplies in from many different countries with many different currencies. And it's just too much for a normal Treasury team to manage. So they tend to not invoice in local currency and prefer to just pick a major currency. Like you say, dollar might be more stable for some cases, so maybe they would go with that one.
00;25;20;18 - 00;25;48;25
Unknown
But because of this awareness of the additional FX exchange rate that they’re being charged, I think the transition is to move back into or to move towards local currency invoicing. And that is something where, you know, a tool such as Kantox or this kind of automation process can really help because it will reduce the workload by increasing the automation and therefore you're able to bring more currencies in and hedge more currencies more regularly.
00;25;48;28 - 00;26;25;25
Unknown
And I think that that's something that can really shave quite a lot of costs off corporates. Right. Right. Absolutely. Now let's shift the conversation a bit towards the topic of automation and digitisation. And so tell us, what is your experience in applying FX automation with your corporate clients? Sure. So I've worked very closely with Nadia, who works aat Kantox and some of my clients, and one in particular comes up who who has signed on to Kantox, which is great.
00;26;25;28 - 00;26;50;21
Unknown
But like many corporates, their hedging process was quite manual and labour intensive. And the transition we see is that treasury teams are getting smaller and smaller. So when you're having to do these very manual labour-intensive things, it's with a quite a lean team. So this corporate in particular had a large number of subsidiaries, so around 30 and exposures in loads of different currencies.
00;26;50;23 - 00;27;25;21
Unknown
And every month the hedging process involved consolidating 30 spreadsheets with loads of different currencies into one kind of big spreadsheets, showing what their exposures were. And then they hedge them and then they kind of send back those rates to the subs. The spreadsheet had lots of hard coding, manual overrides and the like. And it was one of those where really there was just one person at the company who knew how to do it very well, which introduces a kind of level of, of key man risk that, you know, Kantox can do loads of amazing things.
00;27;25;21 - 00;27;54;22
Unknown
But I think the key thing here was just time saving for the company and reducing some of that key man risk. So by automating the data collection and and the kind of number crunching, it just frees up the teams time to work on other things, such as can we find ways to reduce the carry costs. So this company has exposure in highI carry currencies or check the awful costing is correct or check that the information we're getting from the subs is correct.
00;27;54;25 - 00;28;31;24
Unknown
And I just think, you know, every month they were spending days going through all of this and really just the value out of Kantox there was time-saving and making everyone's life a little bit easier. And yeah, I think it's a good example of I think many corporates I speak to think that Kantox might not be relevant for them because they have quite a basic approach to gathering and editing and, you know, converting their exposures into actual trades and they use spreadsheets and stuff like that.
00;28;31;26 - 00;29;03;27
Unknown
But it's useful to know that even if you don't have a very advanced TMS, there's still a very real role for Kantox to help automate your trading process and save some time and. Right. Well our Daisy Andrew, Interest Rate & FX Corporate Sales at BNP Paribas in London. I think we've covered lots of topics. We started out with general views on currency management and the goals of all CFOs and treasurers.
00;29;03;29 - 00;29;34;22
Unknown
We then discussed the carry trade and all of its implications and we got a really, really interesting and insightful views there from a person who has worked both in FX trading and now for corporates. Right. And we went to discuss a little bit the topics also of automation and digitisation. So a really interesting conversation, Daisy is there something that you would like to add?
00;29;34;24 - 00;29;53;16
Unknown
No, not really. I just think don't be scared of automation. We all use computers and the internet and everything in our day to day lives and it's just another step I guess in the road to get where we need to be and to make sure that we are working as efficiently as possible. So it's always worth a conversation, right?
00;29;53;16 - 00;30;20;06
Unknown
I know that you say that. I do remember that in a previous conversation we had discussed this issue that some teams that are considering automation are a little bit daunted by the idea of applying automation. Right. And so they end up hesitating. How would you go about and solve these type of issues?
00;30;20;08 - 00;30;41;23
Unknown
Yeah, I am. I do remember one conversation where they were afraid that if they had a very heavily automated hedging process and the person who historically had been doing the dealing for, say, the last 10-20 years and knew how to do it manually left then the new people who came in, in this world of heavily automated hedging might not know how to do the manual hedging.
00;30;41;23 - 00;31;13;15
Unknown
And if the system breaks, which you know, we're always aware that there's a chance that might happen, how, you know, how well equipped are they going to be to manually hedge their exposures or work it out themselves? And so it's the same issue that we face in our team. You know, many clients do the hedging over the platform and it's all pretty automatic, but we still need to be aware of how to do the manual trades and how to build them and execute them and book them and that kind of thing.
00;31;13;17 - 00;31;37;28
Unknown
So it's just important that we do make sure that, well, the junior is coming through a trained kind of to be able to do that if the need be. I just think that that is a kind of it's a path we take. We lose some skills, of course, but it's we just need to make sure that we're making sure that juniors and the new people coming in do still have that manual execution understanding and they know how it works.
00;31;38;01 - 00;32;10;19
Unknown
And I guess a way that say Kantox for example, can alleviate those fears by making sure that you are very comfortable with your Kantox salesperson and you do have quarterly updates and training sessions on how to use a software. But on top of that, you, you stay in touch with your MDPs or or whoever you use to trade and your banking partners and, and they can also provide the manual hedging training that you need.
00;32;10;21 - 00;32;38;17
Unknown
I get it. It's scary, but it's just something that I think we're all moving in towards automation and AI and the like. So you I think you're better off just being at the front of that queue. And, you know, taking it as it comes rather than stepping back, allowing your business to suffer because you haven't been moving with the times and kind of make sure that you're right there minimising your FX costs from day one.
00;32;38;20 - 00;33;02;26
Unknown
Absolutely. And remember, we have, all those solutions include all the desired manual checkpoints on any time. Daisy Andrew, again, Interest Rate & FX Corporate Sales at BNP Paribas in London. Thank you very much for joining us in this episode of CurrencyCast and see you next time! Thank you for having me.
