FX Risk Management Plan: What’s at risk and what can you do about it?

By ATB Financial 10 June 2020 4 min read

A business that exports or imports products from the United States might want to consider a hedging program to mitigate risk and gain protection from the volatility of currency exchange rates. Swings in exchange rates can impact a business’ margins and bottom line.

“As companies start to understand how their business is affected by uncertainty in the currency markets, it’s vital they consciously manage that uncertainty,” says Janek Guminski, Senior Director, Head of Foreign Exchange Sales at ATB.

So, how much money could be at risk? Let’s take a quick look at the risks that a US dollar (USD) buyer with a US $1 million purchase in 30 days has. We will calculate the potential cost over the month.

USD/CAD Daily % Changes 2015-2020

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The USD/CAD currency exchange rate has recently seen some wild swings relative to a period of calm during 2019. The chart above shows the last five years’ worth of daily percent changes in USD/CAD. A daily change of +/- 1 percent would be considered relatively rare—highlighted by the horizontal solid green and red lines.

Recently, we’ve seen a number of daily swings well outside historical norms. Based on this information, we can roughly determine what’s at risk over the course of one month for a US$1 million purchase. Let’s see what the numbers tell us:

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This table tells us that with 95 per cent confidence that a business can expect to lose $35,842 or less if the exposure is left unhedged.

This naturally leads to a business asking the questions:

  1. “Am I okay having a potential $35,842 increase in my costs over the next month?”

  2. What happens if we experience an event that is outside the probability distribution—how much would my costs increase in that case?”

  3. “What can I do about it?”

Below we’ll help you figure out how to answer these questions. We’ll walk you through the five key steps to starting your FX Risk Management Plan.

 

Identify exposure

The first step for a business is to examine all receivables and payables to identify where they’re exposed to a foreign currency. This could even be exposure to a commodity that’s valued in USD (aircraft, cattle, etc.). For businesses that sell a product and receive USD in return, the risk is that the USD weakens, resulting in lower Canadian (CAD) revenue. The inverse of that would be true for those needing to buy USD.

Exchange rates are constantly changing—it’s just a matter of whether those changes are helping or hurting the unhedged business. Any business that sells or buys from another country would benefit from a review of their foreign currency practices.

 

Specify goals

The second step is for businesses to consider the magnitude of the impact that exchange rates have on their bottom line. If a business generates 99 per cent of its revenue from Canada, then it might assign zero resources for the other one per cent, where it has currency risk. However, if 30 per cent of the revenue comes from overseas, risk mitigation would be more of a consideration.

Items that would go into goal planning could be to:

  • Do no worse than a certain budget rate
  • Maintain minimum profit margins
  • Reduce volatility of results

 

Develop a plan

Once a business understands its goals, it can begin to develop a meaningful plan for mitigating currency risks. FX hedging is simply a risk management strategy used to limit or offset the probability of loss from negative moves from a currency. A hedging strategy would involve hedging somewhere between zero and 100 per cent of a company’s exposure.

The longer an unhedged company has been in business, the more likely it has been negatively impacted at least once due to foreign exchange volatility and uncertainty. It’s important to be mindful and have a plan in place to reduce the risk of an unwanted surprise.

If you’ve considered all the outcomes and options and still decide to do nothing, that’s very different than not having considered any options and deciding to do nothing.

“You want to make sure you’ve protected yourself before it’s too late,” explains Guminski. “The fact you didn’t in the past and it didn’t bite you doesn’t mean that it won’t happen this time.”

 

Choose your tools

There are a number of different strategies you can implement for hedging with ATB, one of which is FX Forward contracts. FX Forward contracts involve converting a certain amount of currency at a predetermined rate for a specified date in the future. FX Forward contracts are the benchmark to which other hedging strategies are compared. In terms of a risk management tool, they remove all uncertainty; businesses know exactly what the value of that foreign currency is going to be.

Hedging strategies can be tailored specifically to individual businesses, their goals, their needs and their comfort level. But in order for that to happen, transparency is key. “We understand the complexities and nuances of the markets, but we need to have those really open conversations in order to build the customized strategies our clients need to navigate through high-level challenges and opportunities associated with currency exchange,” says Guminski.

 

Evaluate your results

Set a regular timeline for a check-in on what the business’s plan was, what tools were utilized and how effective they were. There will be opportunities to identify areas where new sensitivities and/or tolerances are discovered, likely resulting in modifications to the tools used in future strategies.

Businesses should then update the plan for the next quarter or year. Conversations with your FX expert will help with the selection of the tools. The evaluation should be a regular occurrence, and feed the next iteration of your FX Risk Management Plan.

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Our ATB Business Solutions team will be happy to assist.