I am head of treasury, corporate finance and ERM at RTL Group. I'm also Chairman of the Luxembourg Treasury Association (ATEL) and Honorary Chairman of EACT (European Association of Corporate Treasurers) based in Paris
Climate and diversity are increasingly on the agenda of general meetings. Shareholder activists are putting pressure on with “say on climate” proposals and forcing fund giants like Blackrock or Amundi to make their voices heard more often. Have we not reached a breaking point or a tipping point?
The formidable opponent: « green activists »
Listed multinationals with a large carbon footprint are now facing a formidable opponent. Some activist investors are trying to push corporate management to change course. Some, including the famous Chris Hohn, are trying to launch ambitious campaigns based on the “say on climate” concept. This is like the “say on pay” campaigns, which allow shareholders to express their views on the remuneration policy of their companies during annual general meetings. Companies must take their responsibility in the fight against climate change. By obliging General Managers to present plans to reduce their CO2 emissions and by requesting an annual report on the progress made, they are forcing companies to change, if they do not do so spontaneously. The shareholders leave themselves the opportunity to fire managers who would be in default. They want to get at least 100 of the largest publicly traded companies in the US to adopt a clear climate plan by the end of 2022. Blackrock as the world’s largest fund manager intends to impose this type of climate strategy. However, fund managers rarely vote on ESG measures at general meetings. Beyond the hype, managers need to deliver and avoid false promises.
Say on climate
But the tide has turned since the health crisis began. Managers want to use their active vote to make a difference and make it visible. No more working behind the scenes. Think of the AENA airport group, which has been subjected to a “say on climate” campaign against it by Blackrock. The general meeting is therefore becoming the scene of these confrontations on the ESG aspect. In the USA, the rule allowing any shareholder with at least USD 2,000 of shares during a year to put a proposal on the agenda has changed the situation. It remains a question of culture. The indirect, behind-the-scenes, bilateral strategy works better than the direct approach in a general meeting where the risk is binary (it either passes or it breaks…). It is becoming common to ask questions about “climate”, “health” or “working conditions”, for example.
« Green » watchdogs
Financial watchdogs across Europe are sharpening their scrutiny of potential “greenwashing” in the investment industry on rising concerns that capital is being deployed based on misleading claims. There is an avalanche of new private money pledged towards tacking climate change. It has prompted regulators to step up their work on setting standards to ensure banks, insurers and asset managers provide clear disclosures on the environmental credentials of the investments they are pitching. Green investors can no longer rely on rules of thumb. The new announcement of IFRS “ISSB” is a proof of this clear will. If you (properly) measure the green footprint and ESG maturity, it happens. Now there are very strong incentives to make assertions in the competition to be green.
Activists to defend climate chages
We are therefore seeing a rise in the power of “activist” shareholders who defend ESG strategies and punish companies with a non-ESG culture. Millennials will also completely change the situation because they have no qualms. Bank-based asset managers are now only offering ESG (or pseudo ESG) funds. Shell, Total, Rio Tinto or HSBC have been under attack from shareholders for taking action against climate change. The “black live matter” movement also played on diversity and was another catalyst for profound change. We’ve even heard of racial auditing at Amazon, J&J and other major banks. Rating agencies and news organizations publish many sobering statistics that raise questions. The search for maximum profit is no longer the only selection criterion, let’s face it. It is a pity that it is activists, like Share Action, who move the lines, more than the companies themselves. Institutional investors are also systematically voting in favor of climate change proposals or those that are ESG-friendly. Analyses that show that the most ESG-virtuous companies perform better or are more profitable than others. Performance will also help convince shareholders, but also management. There is still a long way to go. These are all factors that, when combined, will enable Europe to take the lead in terms of ESG.
François Masquelier – Chairman of ATEL
Disclaimer: This article was prepared by François 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).
With so many unexpected challenges from every direction, all CFO’s must ask themselves if they are in the best position to steer the company through the next critical situation. The businesses and operations will look to finance to support innovation, to facilitate internal and external value creation, and to lead workplace “co-creation” efforts. Organizations should ask themselves if they are doing the right things, not just doing the things right. The most resilient posture for the business and the CFO/Treasurer in the face of dynamic and uncertain change is to retain control at the center but ensure flexibility at the edge. The CFO should give the tempo and the “la” for the changes and the revamping of the whole finance function. He/she must be the conductor of this profound transformation. If the CFO does not initiate this change, then it seems difficult for the treasurer alone to achieve a radical change in the organization. If I were a financial analyst or a rating agency, I would check the changes made by the CFO’s. A company whose CFO does not initiate any changes should be penalized by the markets and rating agencies, as it should be. Otherwise, some people will never change the financial environment, believing that they will escape any future crisis if they have survived this one and others before. This is again the simplest attitude to avoid at all costs. The mindset is also crucial: the CFO must be willing to question himself and to consider what can be done better or more efficiently. This is often a problem, as CFOs sometimes believe that everything is under control and works well. Accepting that your organization can be improved requires a minimum of honesty, humility, and sincerity. This is the most important starting point without which we will never achieve our goals.
Rethinking Treasury
Treasurers are the stewards of the information that CEO’s need to make key business and finance decisions. Treasurer’s role is no longer about just cash positioning, and this shed a light on how inaccurate and inefficient existing processes were sometimes. Treasurers have difficulties to change historic systems and processes. The pandemic has forced a change away from dated processes a lot of people were too comfortable with. Rethinking cash flow is crucial, because it is the cornerstone of finance, the focal point, the lever to be activated in priority. To be more resilient and resistant to any crisis, any unusual and contrary element, any extreme market volatility, or any strict regulation, it is necessary to be meticulously organized. This requires automation, a review of basic concepts and better recruitment. The first step is to accept the idea that we can do better and that we must improve the existing organization. This is an essential starting point, without which you cannot move forward. Being able to reinvent yourself, accepting that you could do better and wanting to guard against it is commendable but often difficult to admit. It is easier to be complacent about what you have always done and pretend that it is the best you can do. It is an outdated, arrogant attitude that even the best CFO and treasurer would never have. I admire treasurers who want to change things and accept the idea that better (still) is possible in terms of organizing the function. It seems to me too easy to pretend that you do not have the budget, or the time, or that everything is already optimal. Humility is the most important quality of the modern treasurer. It is not permanent dissatisfaction, but a desire to strengthen his/her organization increasingly to make it more durable and solid. This is audacity and modernity required.
Action plan
We are going to propose few main lines of action for the CFO (with the support of the treasurer). The first axis is the automation of processes such as FX, payments, trade finance operations, or accounting reconciliations. If there was an objective, it would be to banish XL from treasury management or make it minimal and secondary. The second axis is (information) technology, which allows automation of course, but also to manage more dynamically, more efficiently, and to integrate via API’s the systems between them, by optimizing the information accessible on the banking side. It also starts to allow data mining and the use of existing data, but often untapped and unused until now. With this data, it will be possible to produce more relevant, condensed, immediate and relevant reports. The next axis is the optimization of the working capital need, often under-exploited and not maximized. Reducing the working capital requirement is one of the cheapest ways to finance oneself and/or to make beneficial use of one’s excess liquidity, penalized by the still negative interest rates. At the same time, optimizing the capital structure is an important axis. However, the search for WACC should not be maximal, but on the contrary “optimal” (which implies that one does not look for the theoretical optimal level at all costs, but for a practicable and attainable level).
As already mentioned, reducing the supply chain finance (SCF) has become a major objective for manufacturing companies, because here again the factor is a cost element that can be maximized by reducing it and increasing the “cash conversion” factor (or CCC). It has become essential for cash rich companies to limit the cost of negative or low interest rates. This implies reviewing strategies and splitting up the layers of cash according to their use, to allocate them to other, more profitable assets and to seek to generate or extract yield. The treasurer also needs to be more involved in M&A transactions, to help protect investments, reduce their costs, protect new risks, and integrate them into centralized treasury management and group financial reporting. Forecasting of future cash flows was again an issue during COVID. The reliability and relevance of the figures, the ability to crunch and analyze them, by hypothesis, allow the CFO to make faster and better decisions. Production time and the irrelevance of forecasts are his two worst enemies.
Risk management is becoming more complex due to increased market volatility, fraud, and cyber-risk. This requires strengthening internal controls and (back to the first axis) automating processes to mitigate operational risks. What is manually produced is at risk and delivering reports is far less useful than interpreting them. It is impossible not to scan the new financial regulations that are starting to come in. This also requires a more legal perspective. Another critical area is recruitment to adapt skills to new needs. We need to rethink the type of profile we are looking for and avoid hiring only typical treasurers. Soft skills must also be revisited to surround the team with different cultures, new horizons and complementary and more IT skills.
In short, we need to improve on digital literacy and digital skills. Those without access or digital skills would be left behind. In couple of countries, in Europe and beyond, have tried to adapt the education systems to the world of today and of the future, but it is not going fast enough. We must make more efforts to accelerate the digital literacy, especially with young people, to successfully implement this required digital shift.
More resilient than ever
The goal would be to make the entire finance department more resilient and robust. CFO’s have already started down the path to digitalization, with varying degrees of progress and success. Progress is very often slow and gradual, although COVID has clearly slowed it down. Many financial executives, including treasurers, think that having a TMS in place and a “payment factory” is the Holy Grail and that they are therefore completely digitalized. Often, due to a lack of knowledge of what could be done, they stop in the middle of the digitization process. This is obviously a mistake. It is simplistic and reductive. Digitization is the ultimate in automation and the surest security and protection against adversity and financial crises. We can never be automated enough. It is therefore useful and recommended to question oneself. Why not simply perform a treasury diagnosis to see where you left off and what else could be done. At little or no cost, the CFO can get an idea of the productivity gains to be sought. We must also recommend that he never forget the qualitative aspect, the risk aspect to be mitigated and the internal controls, the best possible protection against fraud. Daring to question oneself can only generate value for the whole company and consecrate the strategic role of the treasury. In conclusion, I would say: “Embrace emerging technologies or be left behind”. You should not be afraid because even the highest mountains have a path that leads to their summit, never forget it.
François Masquelier, CEO of Simply Treasury – Luxembourg 2022
Disclaimer: This article was prepared by François 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).
When ESMA is reviewing EMIR refit thresholds by asset class and the definition of hedging (to be opposed to trading) for excluding financial transactions from the threshold’s calculation, corporate treasurers must be cautious and carefully consider the answers they will give to this important consultation. EMIR is now accepted by all and in general respected. Changing rules may cause troubles if they become even more restrictive.
ESMA has recently decided to review the thresholds fixed for each asset class for EMIR obligations of collateralization. This issue of the clearing threshold for NFCs during is an important one. It is important to bring it to the attention of treasurers. ESMA has launched a consultation to review the current clearing thresholds of OTC derivatives for financial (FCs) and non-financial counterparties (NFCs) under EMIR Refit. This exercise is mandated under EMIR Refit to periodically assess the appropriateness of thresholds and update these if necessary. In addition, this report also evaluates the impact Brexit has had on OTC derivatives and clearing thresholds. The deadline for feedback was set for the 19 January 2022. In its assessment of the existing clearing thresholds, ESMA expressed to be overall rather satisfied. In particular:
• Ensuring effective and proportional thresholds – which indicates that thresholds for FCs adequately capture sufficient OTC derivatives without unnecessarily burdening smaller counterparties. This is ESMA’s first assessment since the introduction of exemptions for FCs which established the category of FC- and signals continuation of the current framework.
• Deeming useful the hedging exemption for NFCs – as OTC derivatives to hedge commercial risk have proven their purpose and assured a proportionate impact of the threshold.
• Maintaining current thresholds – based on ESMA’s calculations which suggest that slight alterations of the thresholds do not have any significant impact on the number of counterparties and notional captured by the thresholds.
• Fact-finding exercise for relevant considerations and data – on the coverage of clearing thresholds and the functioning of the EMIR framework in general and on additional aspects to be mentioned in relation to the hedging exemption. ESMA offers the possibility to submit additional evidence in a series of open questions.
In relation to consequences drawn from Brexit, ESMA seeks to assure clarity and stability despite the change of status of UK markets. ESMA is searching for solutions beyond equivalence decisions – since third-country markets are not recognized under the EMIR regime and trades therefore contribute to the overall OTC position towards the clearing threshold. In this context, ESMA expresses openness towards exploring solutions and alternatives to the lack of an equivalence decision (Article 2a of EMIR) to alleviate concerns. It also highlighted the importance of maintaining regulatory stability – to be ensured by minimizing market disruption. For this aim, ESMA is collecting examples and supporting data on practical issues related to the calculation of thresholds including fungible ETDs and OTC derivatives, transactions that do not qualify as hedging and views on the functioning of the EMIR framework.
In addition, ESMA is seeking feedback on the need for further clarifications related to certain topics, notably including:
• Hedging positions of NFCs and FCs within the same group – related to a question raised to the Commission on whether hedge trades by an NFC count towards the clearing thresholds when calculating the positions of an FC within the same group. Clarifications on this issue will be included in the ESMA EMIR Q&A in due time.
• Third-country counterparties – which would be considered FCs or NFCs when located in the EU, count towards the calculation of clearing thresholds.
In terms of next steps, ESMA will collect responses to the consultation until 19 January 2022 which will be subsequently consolidated in a follow up report to the European Commission in 2022 and in parallel ESMA will add clarifications to the EMIR Q&A. In addition, responses to this consultation will feed into an upcoming ESMA review report, due in June 2023, covering the level of clearing, data quality, changes to the EMIR reporting framework and the accessibility of the reporting framework.
François Masquelier, CEO of Simply Treasury – Luxembourg – December 2021.
If there is one word that has marked the financial markets in 2021, it is the term “meme”. Indeed, we can remember the saga around the stock listed in New York, GAMESTOP and what followed. From history, we must remember that the markets are not always right, but the masses are and that technical elements can appear secondary in a world of social networks, of absolute mimicry, of influencers “dictating” the rules (even for investments) and that sometimes David can constrain Goliath. The fact remains that markets will have to react differently, and that “classic” and historical investors may encounter powerful and devastating headwinds.
Buzz word of 2021
If you were to pick THE financial word of the past year, “MEME” might qualify as the best one. You may remember the GAMESTOP saga when frenzied retail buying and social media pushed the stock price up 2.700 percent in 20 days, in early January, and forced 900k people to trade on a single day. We even faced a similar story with AMC, film group. No one could dare to claim they were solid companies in a booming sector with high expectations and huge potential growth. It is the same with PELOTON, a fitness equipment maker, which was more promising.
Some stocks, for unknown reasons or because they were traded “short”, have captured the attention of stock-exchanges, traders, regulators, supervisors, and lawmakers, as a band of amateur traders on Reddit forum teamed up in an effort to squeeze big-money short sellers. Imagine a struggling video game retailer chain – experience wild volatility as members of the subreddit ganged up against hedge funds holding short positions in the stock. Here, we faced professional short sellers (e.g., Melvin Capital) in front of a herd of individual “small” investors. The latter use the forum to discuss trades and follow pieces of advice. We should keep in mind that these short sellers have long been labeled as unethical since they profit when most people are losing money and when stock prices drop. “Meme stock” is a slang used in trading world to refer to stocks with heavy-short interest that can be artificially manipulated to prove a point. Such stocks are often mentioned often in trading-related posts on social media platforms, online discussion forums and news articles. They are popular among younger “Y gen” traders, volatile, and their value is based on potential instead of financial performances. Of course, generally, these stocks are overpriced, all because of market speculation, resulting in huge changes in their valuations and peaks of rapid moves within a short period of time. However, this is not to say that meme stocks are bad stocks. At the end of the day, whatever the value of the underlying company, the most important thing is to make money (but not being manipulated). Most of them have acceptable fundamentals but sometimes they are overvalued, and some traders tend to panic sell when it drops and have a fear-of-missing-out when the stock rises. These stocks gain in popularity when their prices soared significantly. KODAK or HERTZ, as examples, saw their prices surged when they became REDDIT darlings. The meme stock trading mania accelerated in early 2021 when some traders poured money into stocks such as GameStop. It all started as an internet meme by a handful of pranksters on investor forums, and it suddenly turned into something far bigger than anyone could have imagined. Small traders on REDDIT, for example, were frustrated because more than 100% of GameStop shares available for trading had been borrowed by Hedge Funds to bet against the company. They decided in sort of reaction to buy stock in a concerted effort to oppose these funds. It became a massive trend that saw millions of traders to try to cash in on GameStop volatility. It became a battle, a war, a crusade. As a result, hedge funds who had taken out “short” bets in GameStop lost a total $12.5 billion in a month time. The meme stock craziness has forced hedge funds to start paying much more attention to what smaller traders are doing and what they discuss on social media sites and pitch ideas for stocks to target.
Frenzy of social media masters
It reveals how our collective dash into cyber space is reshaping the financial markets. The digital tribalism and tunnel vision can make the difference and change the rules. The power of social investment media is undoubtedly. The TRUMP SPAC saga also illustrated this shift in market behaviors and rules. It seems that new entrants can play the lottery stocks. The nature of lottery stocks has long been a topic of debate in the behavioral finance community. Journalists loved this David against Goliath story. But the new investors are gamblers, and some like with crypto-currencies view it as a game, convinced they can make a lot of money and potentially a job out of it. We see the strengths of these waves ad it requires attention because it may be irrational, not based on fundamentals and risky. Being rational may be a handicap in such a world where investors follow guru’s and trends. This cyber-tribalism is a new concept we must accept and monitor. It is difficult for policy makers to react properly. Only when people will have fingers burnt, will they be more cautious. The conclusion of these crazy stories is that in finance, we need to study patterns in cyber space as much as economic fundamentals to grasp where markets can move to in the short term, at least. I am convinced we will see in the coming years similar stories as investors often learn slowly and because the new generations will grow and better balance “classic” Wall Street” type of investors. It will come to Europe sooner or later, be sure of that!
François Masquelier – Simply Treasury – Luxembourg 2022
Disclaimer: This article was prepared by François 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).
FX hedging strategies should not be based on market volatility, whatever its level. If well implemented with appropriate IT tools, a FX policy should work perfectly independently of any market changes. Conversely, to navigate turbulent waters, treasurers must be well-equipped with FX-proofed IT solutions aligned to the pre-defined and tested strategy. A strict discipline in monitoring FX policies enables good results and prevent P&L disasters.
Is FX volatility a hedging strategy factor
Companies generally regard rightly FX market volatility as a bad development to be avoided. Treasuries want predictability of revenue and costs to understand exactly how healthy the company’s cash flow will be and to preserve operating margins. However, according to American Express, a whopping 65% of small and medium size companies would not use any hedging strategy to mitigate or offset their FX risk at all. It may shock treasurers of MNC’s used to largely hedge exposures, according to pre-defined strategies. Only a well-balanced business could offer a proper offset and enable a company to avoid hedging. It exists, but it is seldom. If you think about it, the currency volatility is characterized by frequent and rapid changes to exchange rates in the forex market. Understanding forex volatility can help you decide which currencies to trade and how. Volatility in forex (trading) is a measure of the frequency and extent of changes in a currency’s value. A currency might be described as having high volatility or low volatility depending on how far its value deviates from the average – volatility is a measure of standard deviation. More volatility means more trading risk, but also more opportunity for traders as the price moves are larger. Nevertheless, CFO’s and Treasurers of the “real economy” are not “trading” at all.
FX strategies should be independent from FX volatility, even if extreme
However, when markets are (hyper) volatile, hedging strategies should not change, or marginally be adapted to hedge slightly more of the non-hedged off-balance sheet portion. I don’t think market volatility should completely and significantly change a hedging strategy, if well thought, well implemented and if processes are fully automated and systematically applied. That’s the recipe for not being affected at all by market volatilities and shifts. The problem with currency volatility is the difficulty to identify it and to track it, because volatility is, by its very nature, unpredictable. If unpredictable, how do you want treasurers to adapt strategies? It would be tough and risky (even if there are some methods of measuring volatility that can help traders predict what might happen). Furthermore, to complexify the topic, there are also two types of volatilities that need to be addressed for an accurate measure – historical volatility and implied volatility. Historical volatility has already happened, and implied volatility is a measure of traders’ expectations for the future (based on the price of futures options). Again, as it is complex and not the real economy business, better to implement a solid strategy fully independent from any volatility or crises. Historical charts, market analysis and forecasts are useful to assess market trends and adjust or fine tune the strategies, when there is headroom for such refining.
Exposed SME’s and treasuries with floating FX strategies
In some studies (and course it varies from study to study but gives a fair and rough idea of the situation), we found that a third of SME’s in the US have reported gains, or losses of over a million Dollar due to FX volatility. At the end of the day, whatever the precise amount, gain or loss on your P&L is simply not acceptable. Think about it, in a couple of second the whole margin of a deal can be swallowed by a fluctuation in a currency pair. Too bad! Therefore, the key factor in FX management is “time”. Timing is the element to ensure. The faster a risk is identified and reported accordingly to treasury, the better the hedging level. Ideally, apart from swap points (positive or negative / premium or discount), the spot of an underlying business exposure should be matched and equal to the spot rate of the hedging instrument. It is there that the most often there are problems: in the pre-trade phase before the hedging decision. Why? Because there are no automation between the tools (if any) or XL to capture a business transaction in foreign currency and the message to the treasury department supposed to hedged it according to a pre-defined FX strategy.
Reasons for foreign exchange volatility to remain high in 2022
As said earlier, we should not base our strategies on FX volatility. Nevertheless, as it should remain high, it reinforces the idea of revisiting the FX strategy. There are three reasons for still high foreign exchange volatility in 2022. There are, as always many factors that can bring volatility back or to maintain it at high levels. The first one is the divergent central bank monetary policies. The short-term outlook for continued US Dollar strength looks good. The worst of the pandemic is all but in the past and in the economy is improving fast. That is the paradoxical situation we face with a longstanding COVID with new waves and variants, when the economy seems (in many sectors) to be bullish. However, bearish analysts point to the fact that the Federal Reserve monetary policy should remain unchanged as a sign that the greenback’s strength will taper off soon (again), especially when other central banks are tightening their own policies. Some central banks could be tempted to reduce their own asset purchasing programs while more broadly, some other banks have signaled that they intend to change and tighten their monetary policies. The second risk is the rising inflation. The Federal Reserve is purchasing USD billion every month in treasuries and mortgage-backed securities, as well as maintaining its interest rate at a near-zero level to support economic recovery from the pandemic’s impact. However, it is alert to the risk of rising inflation. It now has couple of interest rate hikes in mind by the end of 2023, which is sooner than it had previously indicated. The first of these is expected at some point in 2022. Some large bank CEO’s even that the banks were “effectively stockpiling” cash, because of a “very good chance” that inflation was here to stay. The third (but not the last one) reason is the asset-purchasing tapering is nearing. While the Fed gives no indication as to when it will start to taper off its asset-purchasing program, it will likely occur in or around the first quarters of 2022. It takes time to the economy to adapt to interest rate increases. Of course, these three themes may cause varying degrees of volatility in FX markets into 2022. There is possibility for unforeseen or unexpected developments. For instance, these could include: the possibility of a new coronavirus variant causing restrictions again. The central bank policies are not yet written (unfortunately) given uncertainties.
“Should I stay or should I go?” (The Clash)
Not hedging is not really an option for corporations. While a company may benefit from foreign exchange volatility, such exposure essentially amounts to speculation or, should a currency’s value fall sharply and without warning, it could be viewed as outright negligence. Moreover, a company can still protect itself from downside risk while leaving itself open to FX gains, with simple tools such as limit orders or options contracts. However, critical to a strong FX volatility strategy is access to highly accurate, detailed FX daily and forward rates kept up to date in real-time. Solid protection from FX volatility can be simple yet highly effective, if well thought and with ad hoc IT tools to automate processes and be systematic. Companies that use more than one currency needn’t leave themselves exposed to the mercy of the unpredictable FX market. With a simple strategy in place using reliable, precise FX data at its heart, complemented by simplified but efficient tools, clear policies in place, automatic limit orders, spot-forward contract approach, organizations can enjoy markedly improved protection from FX volatility.
Don’t be too complacent to FX volatility
In the past, low volatility in the FX markets was making corporate treasurers complacent. Some thought trends were easily identified (although intraday volatility could be huge). Some smart treasurers explored how while spending money on hedging strategies can appear to be merely a cost, the low volatility atmosphere that we were in at the start of 2020 was very unnerving and changed quickly. I do not think it is the treasury duty to adapt permanently the FX strategies to the economic climate. It would be risky, exhaustive, and time-consuming.
The economic history showed that the markets move in cycles, and volatility may spend some time at the lows, but it will definitely not stay there forever, but not disappear completely either. When black-swan events arise, better to be protected and equipped, with the right IT automating solution and proper policies. And with potential interest rates increases, in some currencies, swap points could be expensive. And it is similar with hyper volatile currencies, as we faced it last year (e.g. RUB, TRY, BRL…), it may be impossible to hedge them, unless you adopt a dynamic hedging strategy with adequate tools like KANTOX.
The solution: a good preparation and perfect tool box
Treasurers and CFOs should have a hedging policy in place that protects them from any adverse FX moves currently priced into the market, but also and more important the ones that are not. The current world economy offers many catalysts that can quickly change the currency markets. A good treasurer must assess the corporation views on the market and risk appetite and tolerance. They must ensure they have FX toolbox (whatever but not only a TMS) in place. The tools must be aligned to strategies. Having a strategy impossible to respect or to monitor would be a non-sense. They should also not perceive hedging as starting at dealing a financial instrument with a platform. It is great to focus on the execution. However, if the exposure has been identified late, it doesn’t make sense.
Take-aways
The take-aways are the following: use a systematic approach because it makes the economic situation largely irrelevant. Centralize hedging at HQ and do not try to push FX risk on your counterparties, it eventually would have a cost. Adopt state-of-the-art technologies (on top of your TMS and FX platform if any). Assess FX financial risks and not the accounting risks and therefore hedge off-balance sheet exposure if highly probable (for qualifying for hedge accounting). These off-balance sheet items hedging require excellent cash-flow forecasting tools too. You should not consider the automated strategies are fixed and cast in stones. An FX policy is never rigid and new IT tools enable to adjust when needed, for example by adopting dynamic hedging strategies, by changing percentage of unhedged portions, by changing the patterns pre-defined, etc.…. Eventually, the more individual transactions a corporation has, the more it requires tool to automate processes and apply one-to-one approaches. The B2C businesses are typically the perfect example. Automation enables to mitigate risks and remove operational risks around one of the most manual management areas in treasury. When crises arise, another complex risk to handle comes from cancelled orders and unwinding of hedging instruments to be properly tracked into the portfolios. As timing has been mentioned as the top priority, the strategy must be applied 24/7 and there again, automation is needed, especially when teams must work from home with all the risks it involves. Some treasuries have been hit during the COVID by the absence of ad hoc tools. And you know that once burnt… IT tools give the flexibility and are not binding at all (the opposite).
François Masquelier, Simply Treasury CEO – Luxembourg – 2022
Disclaimer: This article was prepared by François 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).
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