For companies that deal with customers or suppliers overseas, FX risk isn’t just a matter of chance. It can erode margins and eat away at competitive positions over time.
Fortunately, there are tools to help mitigate your foreign exchange risks. But like planning an international trip, implementing an effective risk management program takes time and customization.
Risk Assessment
For a business that is operating in international markets, currency risk is one of the main risks they need to be aware of and actively manage. With regulations that vary across jurisdictions, multiple currencies to manage and processes that are vastly different from domestic trade, foreign exchange is a complex arena that must be managed efficiently.
A company may also be subject to the risk of its supply chain being exposed to FX rate fluctuations, as they often use a variety of different currencies to calculate their prices. This can lead to major losses, so a treasury manager needs to take a proactive approach in dealing with this risk.
Risk assessments in FX risk management can be delivered using two standard risk metrics, namely Value at Risk (VaR) and Expected Shortfall (ES). AI-Risk-Assessment leverages these methods to deliver an efficient and timely intra-day risk assessment, enabling online data aggregation for data in-flight and at rest while simultaneously performing analytical query processing.
Risk Mitigation
Foreign exchange (FX) risk is a major concern for organizations that do business abroad. It can negatively impact earnings.
FX risk can be managed through hedging strategies, including futures contracts, forward contracts, and options. These can help to offset the impact of currency fluctuations on a company’s financial performance.
Hedging can also be used to mitigate other risks that can affect an organization’s ability to operate effectively, such as transaction risk and translation risk.
The most common form of hedging is a forward contract. This allows an exporter to receive a predetermined payment in a foreign currency even if the exchange rate fluctuates.
Another way to mitigate FX risk is by adding exchange rate protection clauses to a commercial contract. These clauses will provide a refund of the exchange rate difference if the exchange rate deviates from an agreed amount during the time of the agreement.
Risk Monitoring
FX Risk Management is a key part of any company’s strategy to manage its exposure to currency fluctuations. It includes identifying and managing both transaction exposure and economic exposure, which can impact the company’s cash flows and profitability.
It also involves creating a policy and communicating it to the wider team. A policy should describe your organisation’s attitude to currency risk and outline appropriate responses to currency movements.
Ideally, it should be in line with the company’s corporate financial risk management objectives. This will help ensure decision-making aligns with broader objectives and minimizes any misunderstanding among senior management.
Identifying the best hedging strategies for your business requires a lot of planning and consideration. This should take into account the amount of risk you’re willing to absorb.
Reporting
Managing FX risks involves the ability to identify and monitor FX exposures. Exposure can occur through transactional transactions (sales and purchases denominated in foreign currencies) or economic exposure (changes in the value of assets and liabilities held in foreign currency).
Using data from multiple sources, including ERP and financial systems, companies can analyze their long-term exposure to ensure that they’re making the best use of their resources. Analyzing these exposures will help to determine how much FX risk they should be taking on and whether hedging is needed.
There are a number of challenges that can hinder an organization’s ability to effectively report in FX risk management. Some of these challenges include lack of standard processes, disparate treasury systems, and poor integration with business operations.
