Managing FX currency risk

As the dollar strengthens against the euro and emerging market currencies, both European and American companies are finding that movements in the currency markets can disrupt earnings.  Without effective management, revenue from export markets and costs from foreign suppliers can fluctuate, undoing the potential benefits of operating in a global market.

This volatility seems set to continue, according to Ron Leven, head of FX pre-trade and economic strategy at Thomson Reuters. “It’s no coincidence that the upturn in volatility we’ve seen since the middle of last year has paralleled the market pricing-in of rising interest rates,” he says. “It’s probable that if higher interest rates in the United States continue, we’ll see high volatility and a stronger dollar.

“This creates credit-related risks because much of the world, particularly the emerging world, is dollar financed. It would also potentially put pressure on currencies that are pegged to the dollar and will therefore strengthen, thanks purely to that link rather than anything in their own economies.”

Major uncertainty and volatility in the eurozone is being caused by a possible “Grexit”.  However, Mr Leven points out that even if Greece remains within the euro, managing its transition to a better functioning economy will still create pressures possibly leading to a re-pricing which will affect other countries.

The corporate treasury department will need to identify the extent to which they can tolerate currency movements and when their earnings forecast starts to look at risk

Set against the backdrop of these European and wider global challenges is a renewed focus on foreign currency risk management, in particular an increased pressure to optimise working capital and ensure efficient cash management. Given these factors, how can corporate treasurers look to leverage the latest technology to manage their foreign exchange (FX) risk effectively?

The first step, says Neill Penney, head of FX workflow at Thomson Reuters, is for companies to recognise the inherent risk and develop a strategy for managing it. “A company’s corporate treasury department will need to identify the extent to which they can tolerate currency movements, as well as identifying when the earnings forecast they presented to their investors starts to look at risk,” he explains.

“That can drive strategic decisions, such as where to locate factories, in order to create natural hedges where income and costs are in the same currency. It also affects more transaction-oriented solutions, such as whether they’re hedging out particular payments or revenues.”

The simplest strategy for corporate treasurers is to lock in rates for their expected foreign currency payments and receipts. “For example, if they know that in three months they’ll receive approximately $1million-worth of foreign sales, they might decide to exchange those receipts ‘forward’, locking in the rate today for the currency exchange in future. This means that whatever happens to currency rates over the next three months, they’ll know the rate they’ll receive and hence the amount in their home currency,” he says.

To benefit from this and other foreign exchange strategies, more and more corporate treasurers are relying on technology to access essential data from which they can make more informed decisions about their foreign currency hedging.

Faced with the need to achieve greater efficiency and automation, they are on the search for desktop and mobile solutions with tools that provide easy access to trusted news, data and analytics, all filtered by relevance to the user’s needs and displayed in a highly visual way that’s easy to understand and act on.

As an example, corporate treasurers may look to solutions that provide a better understanding of the fixed rates available for hedging their FX exposures at different time horizons. “This is the so-called forward curve and it’s determined by the difference in interest rates between the two currencies, rather than the market’s view of whether a currency is going to go up or down in the future,” says Mr Penney.

“A corporate treasurer studying the curve may decide that certain maturities on it look particularly cheap or expensive, depending on their own view of the currency risk. Our trading tools let corporate treasurers refine their views by asking for tradable prices from their FX brokers. These prices will depend, of course, on a company’s credit rating, the size to be transacted and the broker’s appetite for that currency at that time.


“The trading tools then let the treasurer move seamlessly from comparing prices to trading with the broker of their choice and finally to automatically booking the trade in their treasury management system. Our system also captures prices from the other brokers, as well as the original indicative price, so the treasurer can subsequently establish ‘best execution’ in line with their company’s trading policies.”

However, increasingly, corporate treasurers are now opting for a more sophisticated approach using options, according to Mr Penney. “The dollar is getting stronger now, so if you’re a US company that’s selling abroad, you’ll find the same number of euros earned in an export market generate a decreasing amount of dollar revenue. A corporation might decide that it can tolerate a general rise, but at a particular level the situation becomes critical because the company’s earnings forecast is now at risk,” he explains.

“Options enable the company to craft a hedging strategy around that particular rate. They’ll be able to ensure the company achieves its target level under a much wider set of market conditions than using forwards to hedge. But in return, they have to give something up. This might be, for example, accepting a worse exchange rate than a forward-based hedge should the market not move as far as the target level. Overall, they have a more effective hedge because it’s tailored explicitly to their critical levels and holds under a wider range of market movements.”

Mr Penney adds: “Usually, rather than a single option, customers will want a strip of options that match the various payments and receipts they’re expecting. Designing a hedging strategy is best done by experimenting with different what-if scenarios. It involves finding a balance between the different market risks the treasurer is concerned about and the cost of neutralising those risks.”

With accurate information and modelling tools to hand, corporate treasurers can work more effectively with their FX brokers. Many of them find electronic trading platforms further help them by automating the execution and booking of the selected hedging strategy.

It seems as if the global economic and political uncertainty will continue, with the effects on foreign exchange markets presenting serious challenges to companies trading abroad. In this volatile world a proactive, forward-looking hedging strategy, supported by accurate, timely information, is essential for corporate treasurers.

Thomson Reuters offers a comprehensive range of solutions for corporate treasurers. For more information visit