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Treasury Departments are the First Line of Defense

By Tom Cleveland
Posted: 16th April 2012 09:51

At one time in the not too distant past, international commerce was primarily the private playground of large corporate enterprises.  Transaction sizes were large, supported by expensive “letter-of-credit” processes involving a host of bankers, lawyers, finance professionals, and shipping companies.  In today’s modern era of globalisation, this outdated landscape has had to change dramatically as companies of all sizes have sought revenue growth from a variety of global strategies.  Off shoring has been ongoing for decades, but selling directly to new customers across the planet is the new norm.

International trade presents its share of unique risks, most notably, the exposure to fluctuating foreign exchange rates, commonly referred to as “forex” risk.  For the past year alone, major crosses with the U.S. Dollar have gyrated between 10% and 20%.  Margins in cross-border commerce may be on the healthy side, but the potential for a shift in cost of 20% over twelve months will get a CEO’s and Board’s immediate attention.  A “Treasury Policy” document typically specifies exactly how forex risk should be defined, measured, and hedged, if material.  Financial statements must also contain disclosures that reveal these exposures and how they have been handled over time.

Large companies have learned to deal with currency risk and have devoted considerable resources internally to develop analytical infrastructures to minimize the financial impacts in this area.  There was a time when simple forward contracts were used to lock in current rates for the future, but in today’s modern financial markets, the tendency has shifted to employing various option strategies to protect against downside risk, but also retain a stake in the upside potential if currencies movements are favourable.  Mid-size and small businesses have also joined the fray, quickly learning the benefits of controlling forex risk.

The hedging process starts with defining a company’s foreign exchange exposure by addressing the key issues. Treasury analysts within the Finance Division shoulder the responsibility for mitigating currency exposures, employing the following 5-Step program:

1) Define the Risk:  Each company situation is unique, depending on how and where it sells, operates, and obtains its raw materials or services.  The four areas depicted in the graphic form the basis of this definition;

2) Define Measurement Methodology:  Analysts must determine which internal reports will provide accurate data for estimating current, as well as future, exposures.  Assets and liabilities constitute one area of focus, and revenue and expense streams comprise the other;

3) Gather Data and Estimate Exposures:  This step presents a practical challenge since forecasts are involved and timely data reflect on the accuracy of the process.  Assets and liabilities, together with revenues and expenses, are “pooled” within a specific currency, and the resulting “nets” represent the exposures, both now and going forward.  Analytical models then allow for “what ifs” to be reviewed to size the risk potential;

4) Develop a Hedging Strategy:  Companies can decide to hedge, not to hedge, or modify the way they are doing business.  If the net exposure is small and the cost of hedging is prohibitive, then a firm may elect to proceed un-hedged.  The company can also focus on minimising existing “net” exposures by modifying the mix of assets, liabilities, revenues, and expenses between native currencies and the reporting currency of the corporation;

5) Execute Hedges and Monitor:  Options and forwards are the tools of the trade.  Monitoring the book of forex derivatives is active, and periodic reporting follows accepted accounting standards.

Hedging is not for the inexperienced.  Treasury analy sts are skilled in these disciplines and actively provide value for their forex risk mitigating activities.

Tom Cleveland has had an extensive career in the international payments industry with over 30 years of experience in executive management, corporate governance and business development.  Tom served as CFO for various Visa International entities from 1980 until 1999, retiring with the title of Group EVP and Treasurer.  Mr. Cleveland earned an engineering degree from Georgia Institute of Technology and did graduate work in Finance at Georgia State University.  Currently, Tom uses his ever-growing investment knowledge to write guest columns for both  His recent work includes posts on BusinessInsider, Business-Standard, and CreditWritedowns.

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