Corporate FX hedging: Do treasurers have the tools they need | Insights | Bloomberg Professional Services (2024)

This article first appeared in Profit & Loss. It was written by Ken Monahan, Greenwich Associates, specifically for Bloomberg.

Corporations are among the most important customers of FX trading desks. Given that trade and capital flows ultimately determine FX rates, one could argue that they are the single most important group in FX markets. What’s more, for many banks, the FX trading relationship is seen as an extension of the cash management and payments businesses of the bank. Since this is the core franchise of banks, the currency trading relationship can take on a significance beyond the FX business itself.

As with the dealers, so too with all other aspects of the market’s ecosystem, platforms and vendors are also looking to enhance their engagement with the client segment. Given its importance, it’s helpful to get a sense of the tools that companies use to identify their FX risks as well as just how satisfied corporate treasurers are with these tools.

The next four most popular categories—swaps, forwards, NDFs and futures—are all ways to limit future exposures, and manage the rate differential between the two currencies in the interim. These instruments can also contain a credit component. Swaps and forwards are the most straightforward tools for hedging future obligations and differ only in their payment structure with a swap presuming multiple payments and a forward paying off only at the end. A non-deliverable forward is a hedging instrument for a currency that is not fully convertible. This instrument has been growing in popularity as trade with emerging markets has grown.

After NDFs however, the use of other derivative instruments declines significantly. Futures, which are very similar in structure to forwards and NDFs, are significantly less popular despite central clearing and the fact that they trade on anonymous central limit order books. This may be because they are a fairly blunt instrument for corporate hedging needs. Futures are highly standardized products with fixed notional amounts and fixed expiration dates which typically fall within a relatively short time horizon. Corporate hedging needs are typically forecast out relatively far in the future and so would require several futures rolls. Additionally, receivables or payables that occur on fixed future dates are unlikely to match futures expiries.

Notably, vanilla and exotic options are relatively unpopular as well. Given that much corporate hedging is driven by uncertain estimates, or that some hedging needs are either conditional on the level of spot, or conditional on its direction, it is surprising to see how unpopular these are. While this is true for both vanilla and for exotic options, the difference between the two should not be overstated. For corporate purposes, “exotic” options might just possess a knock-out feature, meaning the option vanishes under certain conditions when it is least likely to be necessary. At the same time, many companies’ currency risks may not be severe enough to justify the complexity and cost of managing those risks with options. The recent increase in foreign exchange volatility may change that equation.

For the time being, treasurers certainly seem to believe that they have access to the full range of financial instruments they need to address their risks. When asked, 66% said they were satisfied with the tool set available to them. Only 3 respondents out of 50 said that they could not access all the tools they needed because their dealers did not make them available. One in ten said that they were prevented from using additional tools because they could not be booked successfully in their accounting systems. Given the difficulty of altering accounting treatment or changing Treasury Management Systems, it’s difficult to assess just how harmful this might be.