Tuesday, June 23, 2020 Stamford, CT USA — A surprisingly small number of the world’s largest companies employ sophisticated techniques designed to assess and manage their foreign exchange risk.
Companies use FX markets to hedge currency risks in the course of their businesses. However, relative to banks and financials, companies’ FX needs and strategies are incredibly diverse, varying dramatically depending on the nature of their businesses, their amount of cross-border activity, the structure of the company, and ownership structure.
Because the corporate FX business is so heterogeneous, it is difficult for companies and the banks that service them to establish universal best practices. In fact, almost 60% of the corporate treasury professionals participating in a recent study by Greenwich Associates agree that “the circumstances and the risks of any given firm are diverse enough that it is not possible to establish best practices” for FX.
Despite this variation, it is striking that only about one in five of the large companies taking part in the study employ the VaR or “variance at risk” framework, such as “earnings at risk” or “cash flows at risk.” The VaR methodology is designed for precision hedging strategies using relatively sophisticated instruments and analytical methods that take into account the historical variances and correlations of the various exposures.
“Since our study was focused only on the largest and most sophisticated firms, our original hypothesis was that the risk management philosophy would be as sophisticated as the firms themselves. This wasn’t so,” says Ken Monahan, Senior Analyst for Greenwich Associates Market Structure and Technology and author of The Elephants in the Dealing Room: A Study of Corporate FX Clients.
One reason for the low level of VaR usage is that the more sophisticated strategies are only as good as the data that feed them—and companies in the study have little confidence in the quality of their own data. The lack of reliable data and the complexity of the task at hand makes companies reliant on the FX dealers, with treasurers often asking their dealer counterparties to conduct the VaR analysis on their behalf. “Although FX dealers provide critical support to companies, corporate treasurers are well aware that their client relationships with FX dealers are driven as much by bank lending and cash management functions as by quality of service provided in FX,” says Ken Monahan.
The Hegemons of FX Hedging: A Study of Corporate Clients
The new Greenwich Report provides a detailed analysis of the corporate FX market, including an examination of the top risks managed by treasury departments, how corporates make decisions about FX, the strategies employed by companies to hedge FX risk, relationships with FX dealers, and the primary mechanisms corporates use to execute trades—including the increasing use of more complex techniques like “parameterized auto-execution” and algorithmic trading.