Implementation of Foreign Exchange Risk Management on the Corporates (Part 1)

The impact of Foreign Exchange on the business and how to manage this risk is imperative in this ever-changing world. It is important to understand the business nuances and how does foreign exchange fluctuation impacts the business. It is also important to evaluate the impact of foreign exchange movement on the profit margin. The objective of each Company is to minimize foreign currency risk and use market opportunities to improvise the exchange price on transactions. A Risk Management Framework will be drafted in accordance with this policy to ensure the safety and continuity of core business activity.?

Risk Management Policy:

The foundation for the effective, efficient and secure management of foreign exchange risk is an appropriate and clearly defined policy and organizational framework.

A company’s currency risk management policy is the foundation upon which its currency risk management program is built. Developing and implementing it is the single most important thing a company must do in managing FX risk. It defines what the company expects to achieve, how risks are defined, controls over processes and risks, risk tolerances, accountabilities, and performance measurement. Without a comprehensive and well-thought-out policy, there is potential for chaos.

Foreign Exchange risk management is a critical link in the relay race between the business team and the treasury team. Once the business decision is made, the baton is passed on to the treasury team to manage the FX risk. Given below are a few highlights of FX risk management:

● FX risk management provides protection only during the interim period till the business adapts to the new conditions.

● Risk management is a balancing act between real loss and opportunity loss.

● There is always a competitive pressure, the policy adopted will have a direct bearing on profitability as compared to the competitors.

● There is a need for firms to devise a strategy and policy and follow it consistently no matter the fluctuation in the market.

Within the context of the policy objectives, Treasury’s role is to:

1. Keep track of the Company’s exposure;

2. To provide regular market updates and views on currency and interest rate environment to the management on a periodic basis;

3. Manage the exposure in such a way, the business risk is protected and improve the effective rate.

The Company recognizes treasury risks and wants to align risk management for a business with its overall business strategy. The prime objective is to support business operations and manage its risks effectively.

In the next part of this series, we will look at "Role of Treasurer and types of Treasury"!