Currency Pulse #11 - Hedging And Corporate Governance

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Bi-weekly backtest: central European industrial firm

Our bi-weekly backtest concerns a central European industrial conglomerate that sells components and equipment to the aerospace and defence industry. The firm is exposed to the EUR-USD exchange rate on a large proportion of its long-term sales contracts.

On the contracting side, it sources many components from Brazil, using BRL. The finance team’s primary goal —achieving a smooth FX hedge rate—, is reasonably well-achieved thanks to a layered hedging program that creates ‘commonality’ between hedge rates over time.

The problem lies with the firm’s secondary goals. In particular, the treasury team could do a better job at:

• Delaying hedged execution to reduce the impact of unfavourable forward points on its sales (USD trades at a 1.7% one-year forward discount to EUR)

• Anticipating hedge execution to pocket favourable forward points when buying in the Brazilian currency (BRL trades at a 5.4% one-year forward discount to EUR)

With these concerns in mind, we backtested a monthly layered hedging program on USD sales. Compared with the current quarterly program, the program effectively achieves further delays in hedge execution by reducing the weighted average maturity of the hedges.

Further financial gains were attained by optimising the firm's cumbersome and largely manual process of swap execution. All in all, average savings of €6.71M per year were achieved over the period of the backtest (2022-2019) on hedging USD sales alone.

Corporate governance, FX hedging and narcissistic managers

A comprehensive and recently updated study of FX hedging policies published by the U.S. Federal Reserve finds a strong link between weak corporate governance and selective hedging.

While ‘weak’ corporate governance is usually associated with a low percentage of independent members of the Board of Directors, selective or unsystematic hedging is characterised by:?

• The belief that markets can be ‘beaten’. Selective hedging relies on the premise that managers can beat the market using intuition or techniques to adjust the timing and size of positions in FX derivatives instruments.

• Volatile hedge ratios. Selective hedging translates into hedge ratios —that is, the proportion of the exposure that is hedged— that display above-average variability in size and timing.

A serious, yet amusing, paper focuses on one particular aspect of weak corporate governance: the role of unrestrained, narcissistic managers (*). To arrive at an empiric measure, researchers compute the proportion of first-person singular pronouns (I, me, my, mine, myself) to total first-person pronouns (I, me, my, mine, myself, we, us, our, ours, ourselves) in thousands of public documents in the oil and gas industry in the U.S.

The results are hardly surprising: narcissistic managers are more inclined to use derivatives markets speculatively, as shown by excess volatility in hedge ratios. As the authors put it: “One standard deviation in CEO narcissism increases selective hedging by 8.2%”

Note that ‘speculation’ includes leaving exposures unhedged in an attempt to exploit a view on future prices, interest rates and/or exchange rates. The original Fed study pointed to the reluctance of many managers to hedge due to high-interest rate differentials during the Asian currency crisis, a costly mistake that can be repeated today.

To avoid it, managers can delay the execution of hedges by utilising automated conditional orders. This way, the FX exposure remains under active management throughout — but the impact of the negative carry can be effectively reduced.

(*) Emanuele Bajo, H?kan Jankensg?rd & Nicoletta Marinelli: “Me, myself and I: CEO narcissism and selective hedging”, European Financial Management, Vol. 28, No. 3, June 2022.

It’s a multi-currency world out there

Amadeus, the technology company that provides software solutions for the global travel and tourism industry, is out with some eye-popping stats gathered from surveys on multi-currency pricing and payments:?

• 71% spend more when shopping in their own currency
• 74% are concerned about the final bill outside of their own currency
• 80% prefer to shop in their own currency
• 84% prefer to pay in their own currency

“Travellers like to plan their trips quickly and easily with access to travel merchants around the world. They also prefer to pay in their own currency. If they can’t, they’re likely to buy elsewhere — Amadeus”

The takeaway is clear enough: adding more currencies in business operations is a must in the multi-currency world. As we say at Kantox, currencies are like languages: if you are selling your product in the Danish market, would you promote it in French or in Danish?

Marsh Mclennan risk survey: a tale of two regions

The 2023 AFP? Risk Survey Report shows a divergence of views between treasury professionals in North America and the rest of the world. Whereas teams in the U.S. and Canada are more concerned about the threat of cyberattacks, treasurers elsewhere find it more challenging to manage financial risks.?

Foreign exchange risk management is a case in point. While 61% outside the U.S. and Canada find FX risk “the most challenging to manage”, only 31% of U.S. and Canadian treasurers share that view.?

“The percentage of respondents citing foreign exchange risk as difficult to manage as 12 percentage points higher than the figure reported in 2021” — 2023 AFP? Risk Survey

Another interesting finding concerns banking relationships. According to the survey, 48% of treasury departments appear focused on concentrating their organisations’ partnerships with larger banks (*).

(*) See Fran?ois Masquelier’s article on banking relationships, and also the remarks by Stéphanie van der Haert on the need to add regional or local banks to the portfolio for reasons that may include “geographical coverage” (BNP Paribas’ Journeys to Treasury 2023-24).

Five useful links

1. A conversation with Francisco De Barros. “Cash is like electricity”, says the Assistant Treasurer at Ingersoll Rand on CurrencyCast. Watch the entire episode for a discussion of USD strength, the importance of liquidity management and the strategic role of treasury.?
2. Fran?ois Masquelier on the ‘Treasury Tech map’. Fran?ois Masquelier, CEO of Simply Treasury, has updated his very useful ‘Treasury Tech map’. It’s nice to see Currency Management Automation featured alongside the likes of ERP and TMS.
3. Trade deals are good! Exchange rate volatility falls after a trade deal, driven by a decline in systemic risk. “The average trade deal increases trade by 50 percent over five years, reducing systematic risk by a third of a standard deviation across countries”.
4. Big techs in finance. The BIS has just published a working paper on “Big techs in finance”. The gist: (a) Big techs’ strength is their capacity to reduce information costs; (b) But they lack risk management experience and expertise, and they can wield too much market power.
5. Swedish CFOs and AI. A survey by SEB AB and Deloitte AB cited by Bloomberg shows that 85% of Swedish CFOs see “AI as currently not important” for their business, but would welcome tech developments in cost reduction, efficiency and margin enhancement.?

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