Six-step framework to design a holistic risk management strategy
Managing your currency risk doesn't have to be an arduous process.
Businesses that understand the fundamentals of the FX market can design a more effective risk management framework and increase the profitability of their business.
If you do cross-border business, you may already know the many challenges in a global landscape. Many factors come into play. And this includes FX risk.
Many believe managing currency exposure is an arduous process. Well, it's true if you don't have a plan in place. But with a systematic approach, you can achieve structure and clarity and ensure sound governance.
That's why our FX experts have compiled this handbook that covers a step-by-step blueprint to help you prepare a robust risk management plan. And no matter what growth stage you are at, this playbook will help you transact confidently and activate growth.
Let's delve straight into it!
Six steps to design a risk management strategy
1. Identify
Identify and quantify your exposure to make prudent decisions
2. Establish
Determine your hedging goals based on risk tolerance
3. Design
Develop program suitable to your circumstances and objectives
4. Execute
Implement hedging strategy within your organisation
5. Monitor
Track performance to make any adjustments
6. Review
Compare performance against your hedging objectives
Six-step framework to design a holistic risk management strategy
1. Identify and quantify your FX exposure
- Calculate your FX exposure by understanding how much you need to pay or receive.
- Assess the timing, structure, frequency and certainty of your inflows/outflows.
- Analyse the impact of the exposure on your business based on currency sensitivity.
- Set and calculate your prices, budget, target and break-even levels.
- Decide when to implement the hedging and for how long to maintain the protection.
- Determine whether the costs of your hedging strategy justify the expected benefits.
Insights by Ebury: Always consider the costs, objectives, impact and duration before designing a hedging strategy.
2. Establish your hedging goals
- Determine what you aim to achieve and set goals for it.
- Assess the optimal hedging percentage of your FX exposure depending on your risk appetite. We will cover more about this in detail on the next page.
Insights by Ebury: Our FX experts can work with you to define your risk tolerance and then discuss measures to mitigate them.
3. Design a hedging program
- Define a hedging policy with your FX partner (in this case, Ebury). A hedging policy is a high-level set of rules we follow to ensure that we are on track to meet your needs and objectives. This will contain how much you wish to hedge, how long, and your goals.
- After this, our expert will define a hedging strategy, which involves choosing the right products, execution method and approach to achieve the optimal outcomes and meet the needs and objectives we set out.
Insights by Ebury: In some cases, we may combine different hedging programs to ensure you are always hedged by a certain percentage to meet your goals.
4. Execute hedging strategy
- Think about the execution process, accountabilities and time required for execution.
- Communicate your approval model for your FX hedging with Ebury. This helps us define our execution approach to align with your business processes.
- If you don't have any Standard Operating Procedures (SOP) or other practices in place, develop them and communicate them to all the relevant stakeholders.
Insights by Ebury: Our FX experts will help you prepare SOPs that best suit your business. If you have them, they can assist you in enhancing your existing SOPs.
5. Monitor performance to make adjustments
- Regularly monitor the policy you define to ensure you meet your goals.
- Review your hedging strategy periodically and adjust it to deliver the desired results.
- Adapt regularly to align with market conditions, business goals and risk tolerance.
Insights by Ebury: Be careful to take only strategic decisions rather than those that conflict with your hedging goals.
6. Review and compare
- At the end of your cycle, conduct a comprehensive review of your hedging strategy performance against the goals and the policy you set at the beginning of the cycle.
- Reflect on the learnings and incorporate them within the company's framework to achieve better outcomes in the future.
Insights by Ebury: Depending on the outcome, explore new products and assess whether a different product might be better suited for your needs.
Hedging strategy and risk tolerance
A quick overview of hedging strategy depending on your risk tolerance levels.
As we covered in Step 2, it is essential to consider your risk tolerance level when assessing the optimal hedging percentage of your FX exposure. But how do you assess your risk appetite?
Conservative approach
If you are highly conservative, you may hedge all your currency exposure.
Whilst it allows you to manage your FX risk, you may miss out on favourable market moves.
- 100% protection
- 100% visibility
- 0% flexibility
Adventurous approach
If you are highly adventurous, you may leave all your exposure unhedged.
Whilst you get 100% flexibility depending on the market movements, the risk far outweighs the reward. Irrespective of whether you are an importer or an exporter, currency fluctuations may decrease the profitability of your business, reduce global cash flow predictability and make your business less competitive.
- 0% protection
- 0% visibility
- 100% flexibility
Balanced approach
It is vital to decide the optimal hedging percentage (say 50-75%).
So, when the need to exchange currency occurs, you can either draw down from your forward contract or opt for a spot transaction if the prevailing rate is more favourable.
- 50% protection
- 50% unhedged
Percentage of the exposure: Combination of forward and spot transactions
How does this work with Ebury?
- After walking you through your FX audit, we will understand what you want to achieve and what is most important.
- We will help you define relevant risks and the level of risk you are willing to take on. These risks can sit outside FX. For e.g., if you buy steel components, they are also subject to the risk of the steel price going up.
- This helps us design the correct hedging strategy and then further assess whether this strategy is performing appropriately and meeting your objectives and risk tolerance.
- We will also conduct an in-depth analysis of your current activities and help you identify development areas.
Hedging Programs
Types of hedging programs.
Your hedging program is based on many factors, including the visibility of future transactions, risk tolerance, exposure assessment and the sensitivity analysis of exchange rates.
At Ebury, we even combine different hedging strategies to manage your exposure. For example, our experts may combine layered and rolling hedging programs to ensure you are always hedged by a certain percentage and meet your goals.
Static hedging program
- Associated with a conservative risk profile
- Straightforward to implement
- Doesn't require ongoing monitoring
- Follows a set and forget approach
- Inflexible, even when markets are highly volatile
Rolling hedging program
- Maintain a constant hedge ratio and smoothen volatility
- Flexible, as you can continually adjust your positions
- Effective way to manage risk
- Continuous adjustments may lead to higher costs
Layered hedging program
- Hedge ratios are greater for near dates and lower for further dates
- The longer the tenure and the higher the frequency, the more 'smoothing' effect you create
- Flexible to tailor your program to market changes
Never leave anything to chance or let an opportunity go out of hand.
With this handbook, we hope you feel more confident about managing your currency exposure.
Sometimes, we all need guidance from an expert – if you have any questions or want to protect your business from currency volatility, contact us to discuss your needs or arrange an FX audit.
Email us at info@ebury.com
Get in touch with our expert for anything you need.
The information provided herein is general in nature and should not be construed as financial or investment advice. The information provided here is not legally binding. The information, data or views expressed here is for the exclusive use of the recipient and is subject to changes without any notice. You may ask the support team or your dedicated relationship manager to provide additional information regarding Ebury products.
