Time for CFOs to Uncover Worrisome FX Risk Management Issues

An insightful report from Deloitte, How to Uncover Hidden FX Risks, highlights the need for CFOs to stay on top of worrisome FX risk management concerns. The report urges CFOs to uncover FX risks that seemingly hide in plain sight, whether they are on a company’s balance sheet or in different intercompany transactions.

Although the report is a few years old, the information is still relevant, as the outlook for FX volatility in 2023 points to uncertainty and CFOs are challenged to mitigate the impacts of FX on the value of their organizations. In fact, the recent Deloitte Biennial Global Corporate Treasury Survey reveals that a large number of respondents were concerned that FX exposures were incorrect and not accurately captured. Indeed, survey respondents ranked FX exposure-related challenges as the two highest concerns:

• 83% of respondents cited lack of visibility of FX exposures and reliability of forecasts as the biggest challenge
• 71% of respondents indicated manual exposure identification and capture processes as a major concern

The good news is that CFOs can act now to mitigate FX risk management concerns and find where FX exposures are hiding. Deloitte’s How to Uncover Hidden FX Risks report identifies two main sources of hidden FX risk management exposure:

• Risk from internal functions: treasury, trading, and technology. For example, when an organization’s treasury places hedges without full knowledge of existing offsetting exposures, mishedging or unintended speculation may not be readily transparent.
• Risk from external functions: currency volatility and government-imposed cash restrictions. For example, a potential source of hidden external risk may stem from transfer pricing exposures, when organizations forecast exposures in a subsidiary that are in a different currency from the functional currency of that subsidiary.

To mitigate these two types of risk, Deloitte explains, organizations must dig into the details of FX exposures and forecast cash flows to extract and analyze data regarding transactions at both company and subsidiary levels. The Deloitte report discusses alternative FX risk management approaches, common exposure missteps, and key questions CFOs must ask treasurers to root out hidden FX risk.

Alternative Approaches to Risk Management of Forex

To uncover hidden risk management forex concerns and avert potential crises, CFOs can employ different approaches to identify and mitigate risk, beyond pure derivative hedging. The Deloitte report discusses three ways to address transparent and non-transparent exposures:

First, organizations can set up a central hedge desk to net exposures. As part of the treasury function, this desk aggregates FX exposures to make the most of natural offsets before hedging externally on markets. The Deloitte report suggests organizations can often reduce total hedging costs using this method, although companies need to design their systems for hedge accounting to derive full benefit.

The second emerging trend Deloitte points to is standardization of FX and treasury processes when dealing with decentralized systems, such as those found in emerging markets. The objective with standardization in regards to emerging markets is to limit non-transparency and open the door for other hedging techniques that might be helpful with restricted and emerging currencies.

The third way to approach risk management forex to improve transparency is to link the treasury function with operations to ensure collective effort regarding FX exposures. Strong connections between operations and treasury will help inform organizations about the relationship between business activities and treasury activities related to risk management forex, ensuring companies are protected against market risk and hedge accounting administrative requirements are satisfied.

Common Failures Related to Forex Risk Management Strategies

According to the Deloitte report, if CFOs do not direct their attention to some common failures related to forex risk management strategies, they jeopardize their organizations’ capacity to effectively identify and manage FX exposure. Deloitte highlights the following common exposure missteps:

• Multiple systems and handoffs: limited visibility, time-consuming manual reconciliations, and a narrow global perspective are some of the potential hazards of disjointed treasury systems. Accurately and completely collecting FX exposure data within treasury processes is especially challenging for companies with multiple ERP systems.
• Inability to identify natural offsets: when organizations cannot identify natural offsets, it means higher hedge costs and limited awareness of true FX exposure.
• Big data and modeling analytics: inadequate systems can result in several problems, such as low bandwidth to manage and respond to both increased data flow and operational changes, as well as an increased likelihood that market events and FX analysis will be omitted from decision-making processes.
• Highly manual processes: time-consuming, error-prone manual processes take energy away from important analysis related to forex risk management strategies and other FX operations.
• Inconsistent FX accounting: consistently coordinating FX activities allows organizations to generate reliable, valid FX data and analytics, while avoiding tediously researching reconciliation items.
• Policy and board alignment: the complexities of forex risk management strategies are not always understood by board members, leading to misaligned benchmarks and metrics.
• Enterprise integration: an absence of standard processes creates challenges for efficient FX operations.

By avoiding these common missteps, CFOs can successfully identify and mitigate FX exposure risk.

Treasury and Risk Management: Key Questions CFOs Must Ask

Treasury and risk management are intrinsically linked, and CFOs must collaborate with treasury to fully comprehend threats regarding FX exposure and visibility. The Deloitte report cites three key questions CFOs should ask their treasurers.

1. Do we have the talent and the technology necessary to root out hidden FX risks?

To achieve a successful FX risk management program, CFOs need a treasury team with in-depth FX exposure and derivative accounting experience along with strong market knowledge. However, in Deloitte’s CFO Signals: Q4 2022 report, the ability to attract and retain a qualified workforce was cited as a major internal risk. Reliable technical resources, including a strong corporate technology infrastructure, are also imperative.

2. What processes and procedures does the organization have in place to respond to unexpected currency changes?

CFOs need procedures that quickly and easily provide them answers about how their organization’s exposures affect the bottom line. Without these procedures, CFOs are left in the dark regarding FX exposure and visibility.

3. How are organizations measuring the effectiveness of overall FX management policy?

Not only does an effective FX risk management policy act as a crucial control measure related to FX processes and multi-currency transactions, but organizations without an effective FX plan jeopardize missing out on important inputs surrounding treasury. Specifically, organizations will lack structure to gauge treasury performance, fail to have a framework for analysis in place, and risk losing valuable input from treasury regarding wider corporate decisions that could affect forex exposure management.

What CFOs Can Do

In today’s volatile environment, organizations must work hard to effectively manage the impact of FX risk on their organizations. To help unearth valuable information related to FX exposure and visibility, CFOs must consider alternative approaches to FX risk management, avoid common FX risk management failures, and look to treasury as a strategic partner.

Source:
https://www2.deloitte.com/us/en/pages/finance/articles/cfo-insights-uncover-hidden-fx-risks.html