Currency Pulse #18 — Understand Your Business

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In Understanding Your Business (2022), author Louise Perry raises some important points: Do you know your business inside and out as well as you think? Do you know why it is falling down in certain areas and how you can correct this?

These are very pertinent points when it comes to currency management. In our day-to-day conversations with business managers, we notice that some of them often fail to understand how much their business prospects could improve by ‘embracing currencies’.

So here’s a list of possible FX-related questions to help them better understand their own business:

• FX-induced markups. Why do they exist at all? How can the company protect itself —or benefit from— markups? How do these markups impact the firm’s competitive position? Can they be estimated by using historical FX volatility?
• Types of exposure. If the company has several business lines, could it be that —on account of their different pricing characteristics— each business line will require a different type of hedging program??
• Forward points optimisation. What accounts for the difference between spot and forward FX rates? Can companies increase their sales-to-assets ratio by pricing with the forward FX rate when selling in a currency that trades at a forward premium?
• Swaps. What is the best way to adjust the company’s hedging position to the settlement of its underlying FX-denominated exposure? Why do FX swaps have a ‘near’ and ‘far’ leg? Can material savings be achieved by automating the process of swap execution?

“Know your business”, says Kantox’s co-founder and Chief Growth Officer Antonio Rami, is the most important message for 2024, indeed.

Bi-Weekly Back Test: Flexible Forwards vs. Swap Automation (*)?

A Canadian importer of vaccines and other medical inputs hedges its CHF-denominated purchases with flexible forward contracts. Flexible forwards are agreements to buy or sell a specified amount of one currency against payment in another currency over a defined period (e.g. one month) [see].?

The treasury team likes the flexibility of fully or partially settling the forward contract during one month for the same rate. What is not fully transparent to the team is the high costs of this process.

This is because, as the company’s liquidity providers protect themselves from FX risk, they set the exchange rate at a date that is more convenient to them in terms of forward points, i.e., the difference between the forward and the spot rate.?

For example, suppose the company needs funds before expiry. In that case, it pays the desired amount of Swiss francs at the CHF-CAD rate of the value date of the forward contract, instead of the lower rate that would correspond on account of the Canadian dollar’s forward discount to CHF (about 3.34% for 12 months).

With these concerns in mind, we back-tested an alternative way of letting the company ‘draw’ on its currency forwards. While the approach uses standard forward contracts instead of ‘flexible’ forwards, the process of swap execution is automated in order not to strain the resources of the treasury team.

The savings are material: they represent about 0.20% of the traded volume, which is equal to a third of the savings from forward points in the layered hedging program (not discussed here).

And that’s only for one currency pair. Add the other currency pairs, and the proposed connectivity to a multi-dealer corporate FX trading platform, and pretty soon we start talking about hundreds of thousands of (Canadian) dollars in savings.?

(*) Every two weeks, Currency Pulse presents a real-life case. No names are mentioned, and absolute values are changed. We use simulation tools to backtest, with historical data, our proposed hedging programs.

From Chaos to Control: A Roadmap to Group-Wide FX centralisation?

On March 19, Kantox’s Toni Rami, Simon Chevoleau and Enric Hosta will be presenting a 45 minutes-long Webinar on FX centralisation. The discussion will start with an assessment of the main pain points of existing solutions: high trading costs, limited traceability, and lack of round-up FX liquidity for subsidiaries.?

The webinar will include a live demonstration of how Kantox In-House FX’s automated solution can help companies seamlessly integrate operations between headquarters and subsidiaries to maximise exposure netting, slash FX trading costs and avoid ‘siloed’ risk management.

Specific topics will include:?

• How to centralise FX management according to your business needs

• What might an In-house FX set-up look like, and what it can achieve

• Best practices to maximise exposure netting at group and subsidiary level

• How to optimise forward points across the group?

Best Practices in Treasury: Royston Da Costa

In the latest episode of the #CurrencyCast podcast, Kantox’s Agustin Mackinlay sits down with Royston Da Costa, Assistant Treasurer at Ferguson plc. The discussion ranges from best practices in treasury management, all the way to the potential impact of Central Bank Digital Currencies (CBDCs) in terms of more efficient payments.

Here’s what Mr. Da Costa has to say about best practices in regards to treasury technology and business process automation:?

1. Visibility. Investments in technology should yield better visibility, not only concerning cash, but in terms of every activity inside the group.
2. Connectivity. Plug-and-play, cloud-based solutions allow corporate treasurers to benefit from a wide range of platforms doing niche jobs.
3. Security. Any technology solution must be beyond reproach, not just in terms of robustness, but also in terms of the firm’s own IT criteria.
4. Efficiency. Sometimes it is difficult to quantify these efficiencies from a financial perspective. At the very least, solutions should bring meaningful time savings.?
5. Compliance. This is a key aspect—these investments need to be supported in terms of compliance, auditing and regulation.?
6. Controls. Automation solutions must include a system of balances and checks, with manual controls at each step of the workflow.??Watch the full episode here.

Automation and Precautionary Cash: More Evidence

A surprising paper explores the link between business process automation and companies’ cash management policies (*). The authors examine the extent to which automation enhances operating flexibility—allowing firms to hold less precautionary cash.

“To hedge against large unexpected shocks to cash flow that might otherwise result in underinvestment, firms often adopt conservative financial policies, such as precautionary cash holdings. Can automation lead them to change this behaviour?” — Bates, Du & Wang.

Using a measure called SLAC (substitutability of labour with automated capital), and testing with data from a 2011-2012 global 'hard-drive' crisis, the authors conclude that a firm’s ability to substitute automated capital for labour reduces the usefulness of precautionary cash.

This is not the first time a causal connection is established between business process automation and the reduced need for precautionary cash balances.

In Currency Pulse #14, we mentioned how, according to BNPP’s Steven Lenaerts, the use of Application Programming Interfaces (APIs) to improve visibility over AR figures may allow treasurers to do away with potentially costly liquidity buffers.

(*) Thomas W. Bates, Fangfang Du, Jessie Jiaxu Wang: "Workplace Automation and Corporate Liquidity Policy", Federal Reserve Finance and Economics Discussion Series, 2023.

Five Useful Links

(1) Euromoney on FX centralisation. Euromoney’s Paul Golden discusses the merits and the challenges of centralised currency management in the context of Kantox’s In-House FX. The article mentions the “natural elimination of a high proportion of intercompany FX positions”.

(3) ISO 20022. TMI publishes a detailed analysis of the benefits and challenges of the switchover to ISO 20022, the new financial messaging standard. The article features EY’s Jeremy McDougall and BNPP’s Wim Grosemans.?

(2) Falling FX volatility. According to Bloomberg, the JPMorgan Global FX Volatility Index has shed 45% since mid-2022. Right now, automated FX hedging programs that delay hedge execution are helping companies save millions from unfavourable interest rate differentials between currencies.?

(4) Manual data input error. Writing for the Financial Times, Robin Wigglesworth draws readers’ attention to a manual data input error that cost Norges Bank Investment Management (NBIM) no less than $92 million. Can spreadsheet risk be tamed by using APIs?

(5) VUCA. VUCA —volatility, uncertainty, complexity, and ambiguity— is the new normal in financial risk management, according to Dipak Golechha, CFO of Palo Alto Networks [see]. "In 24 hours, maximum, we need to have the math done to be able to make a decision”.

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