Q1 2022 Currency Moves Drive Need for Foundational FX Risk Tools

Q1 2022 CIR Companion Blog
The latest Kyriba Currency Impact Report for Q1 2022, which chronicles the impact that currency volatility and currency moves has on reported corporate financial results, illustrates what we have been expecting, the strong dollar run, and currency volatility experienced in the first quarter of 2022 is taking a toll on corporate earnings. An aggregate currency headwind of $16.46 Billon was reported which is a significant increase year over year and quarter over quarter. Given what has occurred in the markets in Q2 2022 and early Q3 2022, we can only expect more of the same as more and more major corporates already giving advanced indications that currency moves will have a significant dampening effect on their reported earnings.

Corporate Currency Risk Management: A very challenging market with no end in sight
As was stated in my last blog the job of corporate currency risk management is very challenging right now and with continued volatility, EUR-USD flirting with parity, increasing inflation spurring the likelihood of additional rate hikes, Corporate Risk Managers, Treasurers and CFOs need to bring their A-Game to cost effectively manage currency risk for the foreseeable future. The combination of a strong dollar, market volatility and the increased cost of hedging is spurring a lot of conversations between CFOs and Treasurers and the message is consistent, stay on top of the currency volatility but do it in a more cost-effective way.

What do the numbers tell us?
Based on our FX research team’s Value at Risk modelling simulations, our models indicate that for a representative portfolio of currency pairs, Value at Risk increased by 76% from October 2021 to April of 2022. While from April through July, our VaR models show a reduction in overall volatility, an additional challenging dynamic CFOs and Treasurers are contending with is the impact of rising interest rates on the cost of hedging. During the same period of October 2021 to April 2022, the cost of hedging for the same portfolio of currencies increased by 100%. And while we are seeing a slight drop of in overall currency volatility, the cost of hedging is continuing to climb through July with an aggregate 133% increase of hedging costs from October 2021 to the end of June 2022.

So, what are CFOs, Treasurers and FX Risk Managers to do?
We are seeing to main efforts to manage FX risk and contain costs

1. Reduce exposure and risk through internal actions to reduce the need to hedge and
2. Re-examine the tradeoff between hedging currencies and the cost of hedging to determine if changes need to be adopted.

Internal exposure reduction is often aided by comprehensive analysis of the underlying sources of exposure to see if actions such as converting non-functional cash balances to local currency, selectively settling intercompany transactions, re-classifying short-term intercompany loans to long term loans or if other natural offsets can be established.

From a cost of hedging standpoint, we are seeing a very strong appetite for more sophisticated Portfolio VaR and Cost of Carry trade-off analysis. Many treasury teams that have historically hedged on a percent of exposure-based hedging policy are now considering leveraging a Portfolio VaR strategy that can enable FX teams to hit their FX Risk targets by taking advantage of cross currency correlations. This can help identify which currencies that should be hedged and currencies where hedging can be significantly reduced if not eliminated due to the excessive cost of hedging, while still being able to achieve an overall Portfolio VaR target.

Of course, the foundation for enabling both strategies is exposure data that is timely, complete, and accurate. Kyriba’s FX solutions check all these boxes, and we are seeing treasury teams that put their foundations in place prior to the current market upheavals, navigate these market challenges very well. And fortunately for those firms that still need to modernize their FX programs, they can do so quickly and without a huge impact on treasury or IT resources. If your firm is concerned about the ongoing impact of currencies fluctuations, please reach out to us, we can help you develop a very strong business case to ensure upgrading your FX programs and processes makes it into the next budget cycle and our FX Advisory team can help ensure your programs well designed, robust and will stand-up to internal and external auditor scrutiny.

To view the Q1 2022 Currency Impact Report and learn more about Kyriba’s leading FX Risk Management products, visit, www.kyriba.com.