What are the principles needed for a formal policy on FX?
Joseph Maurer, former Treasurer of Levi Strauss, and currently a member of HiFX, Inc.’s Advisory Council answers …
Foreign Exchange Risk Management is about understanding what your exposures are, and then managing such exposures in the context of a Treasury Management Policy that the Board of Directors acknowledges, understands, and approves.
In identifying exposures, it is imperative you are transparent in making such estimates. “Value-at-Risk” and “Cash-Flow-at- Risk” are two frameworks for doing so.
If the size of your organization doesn’t provide for the effective implementation of such measurements, you might consider simply examining your income statement and balance sheet for major currency pair exposures, and then determine how those currencies have moved since your last budget, then project what financial impact a one unit change (e.g. $0.01 change in USD/CAD rates) will have on your financials.
When doing such calculations, consider natural hedges that are already built into your business model. For example, having 100 million in CAD sales, with 50 million USD denominated; meanwhile also having 15 million in USD purchases thereby leaving net USD flows of USD 35 million.
In developing a FX Risk Management Policy, it is important to:
- Set forth the overriding Philosophy of your Treasury group in managing such exposures,
- Define specific Objectives,
- Delineate appropriate Strategies, and finally
- Ensure that proper Procedures and Measurement systems are implemented.
While not practical to set forth an entire FX Risk Management Policy in this space, I’ll try to provide some useful comments, and abbreviated examples.
The Philosophy
The Philosophy can be as simple or intricate as you’d like. A simple statement might be: “In conducting our primary business, the company is exposed to liquidity and foreign currency risks. The Treasury group will manage these financial risks, and will seek without speculating to protect profits from adverse currency movements.”
The Objectives
Objectives need to be more specific. For example, “Due to the uncertainty of the timing of cash flows, the Company seeks to implement strategies in which specified percentages of each quarter’s projected cash flows are hedged. Given the inherent uncertainties of cash flows, this hedging strategy may have non-controllable circumstances that require increasing the maximum exposure levels in any quarter. Should this be required the Board of Directors shall be notified accordingly.”
Strategies
Strategies meanwhile further sets forth program specifications, such as: “All FX commitments in excess of the equivalent of CAD 10,000 that entail the purchase of foreign currency will be subject to this Policy. Both spot and forward contracts, as well as FX options may be used as part of this program. The Company will use a rolling 4 quarter strategy in which specified percentages of each quarter’s projected foreign net cash flow exposures are hedged, with reducing percentages for the later quarters.”
Procedures and Measurement
Procedures and Measurement systems need to be customized to one’s own organization and must be ones that can be implemented. As stated at the outset, sophisticated measurement approaches exist, but ultimately it is up to each company to properly administer the overall FX Risk Management program.
Fortunately for companies of all sizes there are specialists who can assist with developing, implementing, and monitoring such policies and programs.