Wednesday, April 4, 2012

Ws of Foreign Exchange Risk Management

When risk management motivations are forgotten, problems begin. Defining the objectives of a currency risk management program can be tremendously beneficial for all stakeholders. Articulation of these goals in form of a policy with ongoing education (on the importance of an agreed approach) ensures that  foreign exchange activities are aligned with primary business activities and organisation's risk tolerance. 

The more the time elapses between when an exposure is identified and when an offsetting hedge is placed, the greater the financial risk. Allowing subjectivity could mean more risk.  It is important that time lines are clearly defined on when exposures must be reported internally and when offsetting positions (hedges) must be entered into.  

Accountability is key. Functions and levels of responsibility should be clearly stated while developing risk management system. Many a times such responsibility starts and stops with financial decision makers such as CFO or treasurers.  However decisions that carry financial implications are made at other levels such as procurement  and sales teams. These are primary sources of uncertainty and the process should ensure accountability for communicating actual and expected foreign exchange exposure on a timely basis. Similarly treasury front and back office responsibilities should be defined categorically to ensure that all deals are reported, confirmed with counterparties to avoid financial implication due to process slippage.

Effectively managing market risk requires using hedging tools in a dynamic but disciplined manner. Risk management system / policy should not only define set of instruments that may be used by treasury but also describe criteria to be used to decide on their applicability under different market conditions.

Ensure compliance with extant regulations by regulatory authorities and internal guidelines and the policy should detail the same.  Performance should be measured against set objectives to ensure tweaking (if necessary) of existing approach. 

Ever increasing market volatility calls for a comprehensive risk management approach. Go for it! Well begun is half done!

Wishing you all a successful and profitable FY 2012 - 13!

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