FX workflow automation, a necessary journey, easier than imagined

FX workflow automation, a necessary journey easier than imagined

Who hasn't dreamed of being able to automate all their processes and manage everything at the touch of a button? Today's world and technology can do wonders and without making the treasurer obsolete or useless, it can allow him/her to get rid of laborious, heavy, repetitive, and therefore risky tasks (when manual). Automation has the virtue of making processes safer and securing an activity. Automating foreign exchange management is one of the primary challenges, as this function remains too manual, too risky, too time-consuming, and ultimately inefficient, dangerous, and inappropriate. Technology has invented the CMA (i.e., Currency Management Automation) which is THE solution to your foreign exchange problems from the pre-trade phase, the most important one, to the post-trade phase, the most mastered one (although...). We will take you through this necessary project even in the biggest MNC's.

A good idea, only at first sight...

Often treasurers look for the finest price, the best possible (i.e., "best execution"). However, a "good price" if it covers a risk that appeared earlier and was not covered immediately at time T.0, but in T.1 or later, has no meaning or reason to exist. The objective is, when hedging, to have the hedging price as close as possible to the price of the underlying exposure that is to be hedged. This symmetry, this concomitance, makes it possible to completely reduce the P&L impact (if hedge accounting is applied for Cash Flow Hedge, at least). If there is a gap, even a small one, between hedging and identifying the exposure (i.e., the risk), you create an undesired P&L impact (positive or negative). The art is therefore in the precision of the pre-trade phase more than in the execution (i.e., trade) or unwinding (post-trade). Far too many treasurers get it wrong and think they are doing the right thing when they completely miss it. We will explain how to change this dynamic to truly efficient and automated (as it should be) FX management. The project is not as complicated and impossible as it seems.

The real issue is upstream and not downstream of the deal

If you talk to treasurers of large companies, they will often tell you that their FX management processes are optimal (a bit pretentious, but classic), efficient and automated. They fail to mention that they do not consider the pre-trade phase, which according to them does not belong to them completely, but does not exempt them from integrating it, nor that they only have a TMS as an "automated" tool, to which they have added many tricks, additions, accessories, or tools along the way, the most famous of which is called "EXCEL" in order to achieve this. So yes, in a nutshell and seen from a distance, it is automated. The reality is quite different and unfortunately disappointing. CFOs should be more critical and understand the gaps or areas not fully covered. The "pre-trade" part is THE essential part, the keystone of an optimized FX management. This is where all efforts should be focused and where the CMA solution should be considered, at the very least. If we refer to recent treasury surveys, it appears that foreign exchange risk remains paramount (i.e., ranked # 4 by European Treasury survey 2022 run by EACT). More than one in two treasurers complain about the lack of visibility on FX exposure and identify it as the number one challenge. More than 50% of CFOs have suffered FX losses, impacting their P&L's in recent years (accentuated by the covid crise and the war in Ukraine) on unhedged or poorly hedged exposures, because they were identified and hedged too late. Time is more than ever money in foreign exchange. Let's never forget it!

Where do the problems come from?

The problems due to FX come from different sources: a lack of visibility on cash flow forecasts and too little reliability. Volatility of certain currencies that is subject to unexpected and violent jolts. A manual process of identifying exposures, via spreadsheets or systems that are unreliable and not automated, nor coordinated and consolidated, a lack of understanding of the underlying risks of the business by the BU's themselves or an underestimation of the impacts and harms of the passage of time, inadequate and inappropriate policies or outdated policies in relation to the evolution of the business na?ve and too informal FX practices, an inability to analyze exposures and measure hedging results, a lack of mastery of IFRS 9 accounting rules and hedge accounting, a general lack of understanding of the business by senior management, non-standardized or standardized processes, and finally FX skills that are sometimes too weak. There are many more reasons, the list is long. It is to these that FX automation intends to tackle.

What the 3 phases of the FX process include??

We could say that the three parts are: (1) pre-trade; (2) trade and (3) post-trade, to put it simply. The pre-trade part, in our opinion, is the most important because it is crucial and consists of the identification of the risk, the qualification of the risk and the commitment under IFRS, for example "firm" (i.e. firm commitment) and the accounting treatment that will follow, and the treasury's strategy. Whatever the strategy defined, the treasurer can only apply it if he is informed in time of any exposure, with immediacy to be able to react quickly and avoid any exchange loss. It is vital to know the exchange rate that will apply to the underlying risk, whether it is on-balance-sheet or off-balance-sheet. These risks will have to be listed, managed, updated and consolidated in a single tool (ideally), a sort of mega-database of what will or will have to be covered totally or partially. It doesn't matter what the strategy is, if it is applied correctly and immediately. What will follow, the trading phase where many treasurers, thanks to a platform, think they excel, is only anecdotal. Certainly, the best price is always useful. But a good price on a bad deal (because identified too late) is nothing. And finally, the last phase, called post-trade, includes reporting, management information, accounting, revaluation, P&L calculation, settlement, and payment. Missing the first phase is a guarantee of problems. So, if you don't identify an off-balance-sheet risk or only when it appears on the balance sheet, you may think that from an accounting point of view the impact is minimal. But financially, depending on the time between the commitment, its off-balance sheet life, and its appearance on the balance sheet, it can take years. We can't imagine the loss of earnings or shortfalls.

On top, post-COVID shock to digest

Treasuries did not, after the initial shock of the pandemic, need to be overly concerned about whether they could hedge exposures. A dispersed workforce and local limitations on the movement of people, however, created a very different problem. Manual processes were exposed, and the list of risks to be managed significantly grew. Supply disruption and uncertainties urgently required to revisit processes. Streamlining, automating, and eventually optimizing internal processes were more than a ‘nice to have’ benefit as remote working rapidly became the norm.?Covid simply re-emphasized the existing problems. Some corporate treasurers would argue against greater workflow efficiency, but achieving it is less than straightforward and demands a collective organizational determination that also involves other finance functions and the IT department. While there are common processes, each firm has its own strategies, nuances in how it operates and manage FX. This makes buying an off-the-shelf solution (such as an enterprise resource planning or treasury management software system) challenging, and often disappointing. While it might work on 60% of the necessary workflows, adapting an already-built technology solution can be onerous and expensive if 100% efficiency must be accomplished. It will always miss something important and essential to optimize FX management: the CMA. If CMA’s have been invented, it is to supply missing pieces in FX management and to complement TMS’s on their obvious and normal (we would think) weaknesses. If there is one recommendation post-covid to make, it is to revamp FX management and to automate it as it should be and as best-in-class corporates do.?We always recommend to at least have a look at existing CMA solutions. There are not a lot of solutions. However, those existing, like a KANTOX, work perfectly well and may change your life significantly and make you the best friend of the CFO.

Driving efficiency

Perhaps the biggest hurdle to implementing technological change is knowing when to start and where it hurts. We noticed that most treasuries share one common goal: a drive for efficiency. reasuries are highly motivated to achieve efficiencies. For some this means beating the market on execution, but for many others it is about streamlining and focusing on operational risk reduction. Conversely, in some cases treasurers are willing to retain the same risk appetite when they can manage risk and related expectations with greater certainty. Managing FX risk through automation has been the focus in recent years. The companies want to reduce the volatility around its balance sheet hedging program. For many years FX processes were imperfect in predicting P&L FX results. Accounting rules have changed the paradigm and transparency hit results, very often. It led to some big swings at the end of each reporting period due to exchange rate movements and an imperfect hedge. We must confess that accounting challenges remain, but the reduced volatility of returns and automated workflow mean the finance team can dedicate resources to specific targeted areas to help overcome them. There are still risks of course. Predicting currency movements is a very difficult business but getting much more consistency in numbers and more efficiency in FX management can deliver excellent and immediate results. Investing in CMA pays off fast and can be easily calculated. The journey consists in implementing fully integrated and synchronized workflow solutions across numerous FX activities, including hedging future expected exposures, cross-currency cash management, and cross-border payments and receivables.?

?Fran?ois Masquelier, CEO of SimplyTREASURY – June 2022 Luxembourg

(*) CMA definition: Currency Management Automation is the process of completely automating the entire FX workflow of a company. These workflows start when new currency exposures arise, followed by risk analysis and monitoring, trade execution and post-trade performance analysis and execution.

Disclaimer: This article was prepared by Fran?ois Masquelier in his personal capacity. The opinion expressed in this article are the author’s own and do not necessarily reflect the view of the European Association of Corporate Treasurers (i.e., EACT).