What is the best way to evaluate your foreign exchange hedging program?

It might sound obvious but, you should align your hedging program’s goals to your business goals: the company’s hedging activities should help to move the business forward towards the achievement of its goals. By thinking about your exposure in terms of the risks and opportunities they present, you can easily link these to your P&L, margin, pricing etc. aims, and come up with a set of goals that make sense for the business.

Without becoming an echo chamber, it is key to outline your currency objectives - these should be aligned with your business objectives and importantly, be within your treasury policy / risk parameters. Once outlined, your goals should not deviate throughout the year. It is not uncommon to find yourself emotionally reacting to market news and trends however, this can have significant consequences not only for your FX policy, but for the wider business as a whole.

It is also important to define benchmark - how you measure success of your hedging programme. If you eliminate balance sheet (paper risks) that is one thing, but how hedging policy secured your profit margins is another thing. Sometimes companies win tenders to supply goods and use budget rate for calculate profit margins, sign agreements and exactly at this time need to hedge fx risks if want to secure profit margins. The question is how effective it is - are they hedge exactly at the time they signed agreement or after few hours/ days (that means processes are not effective as markets can go substantially against). So company needs to have processes effective because if not, hedging becomes not effective.

I hedged forecasted cash flows, that data needs to be update regular. By monitoring exposure in real time vs budget targets, that means companies can be prepared for bigger market movements and have more proactive approach than reactive approach (if dont monitor exposure properly, then can have irrational decisions and overreact with market movements).

Often, hedge effectiveness is defined by industry accepted guidelines such as the classic beta metric of 0.8 to 1.25 or a correlation coefficient > 0.8. These are traditional statistical outcomes that prove quantitatively whether a hedge is effective for preferential hedge accounting treatment. However, effectiveness can be an interpretive term and is not always aligned with an entity’s risk appetite. For example, it’s conceivable that an entity achieves a beta of 0.8, and yet it falls outside of an accepted VaR threshold or hedge ratio risk limit as per its currency risk management policy. Thus, when crafting a currency hedge program, it’s crucial to ensure that risk tolerance and hedge accounting qualifiers are understood and aligned.

Good to understand also how different strategies work in different market environments - when it is statistically better chances with option strategies and when with simple forwards. That allows sometimes to combine different instruments and adapt hedging policy based on market context.

It is important to have such guidance that is data based. So good to use specialised platforms that not offer execution, but analytics.

If there is fx exposure, that needs to be hedged. If company not hedge fx exposure or do it without plan or clear defined strategy, that means company speculates. Control that you can control. There are many other things that gets stress in business, so better to have fx risk managed