Increasing demands on currency risk management
Since the outbreak of the global COVID-19 pandemic, there are signs of considerable price volatility on the financial markets. The great uncertainty relates in particular to the possible duration of the pandemic and the economic consequences for the various industry sectors, companies and countries. As the following illustration shows, the uncertainty on the foreign exchange market also increased significantly. Volatilities of the main currencies against the Swiss franc have risen notably in recent months. Against the background of this crisis, managing foreign currency exposures is of key importance in the context of financial corporate management.
Development of the 3-month volatility (annualised) since 1 January 2019
In contrast to all the other currency pairs the EUR/CHF volatility, measured in terms of annualised volatility over 3 months, respectively, has remained almost unchanged at around 3%. This is mainly due to the interventions of the Swiss National Bank SNB, which is attempting to prevent a further strengthening of the Swiss franc against the EUR. In recent weeks, the SNB’s sight deposits in EUR recorded their steepest increase since March 2017. The volatility of the other currency pairs listed has increased markedly since March 2020. The USD/CHF volatility, for instance, rose to its highest level in almost seven years.
Many companies are reporting considerable losses in revenue and profit in the current situation. Losses due to unfavourable currency performance can present an additional burden on the liquidity and profit situation. Management of foreign currency exposures geared towards the business model increases a company’s economic resilience when faced with unfavourable currency influences and thereby the development opportunities of the business.
Especially in times of crisis, particular emphasis should be placed on the structuring of currency risk management. We consider the following three aspects to be key in that regard:
1. Definition of risk capacity
A company needs to be aware of its capacity to bear risks in relation to liquidity, capital resources and debt capacity. Any covenants in loan agreements and other financial restrictions need to be taken into account in this context. A low risk capacity requires a strategy that provides for a comprehensive and consistent hedging of the relevant profit and cash flow figures against currency fluctuations. The criteria for assessing the risk capacity and the resulting objectives regarding the management of foreign currency exposures should be set out in an FX policy.
2. Preparation of rolling and scenario-based cash flow plans
Particularly in times of great uncertainty, any plans must be critically reviewed at regular intervals, any developments reassessed and various scenarios analysed. A dynamic and efficient forecasting procedure forms the basis of this. Based on rolling cash flow planning, future cash flows involving foreign currencies must be quantified as reliably as possible in terms of volumes and timing.
3. Review of the existing hedging strategy
The hedging strategy must be geared towards the defined objectives of currency risk management and risk capacity. Besides the hedging ratio, the hedging horizon, the hedging date and the applicable hedging instruments should be defined in an FX policy.
Based on current cash flow planning, any existing FX hedges must be reviewed on a rolling basis and recalibrated where necessary. Particularly immediate drops in revenue can lead to significant changes in FX exposures, which means that hedges already in place are no longer effective and may even result in additional volatility. The increasing volatility on the foreign exchange markets in connection with COVID-19 show that FX hedging on a rolling basis is clearly preferable to a static, once-yearly budget hedge.
Currency management tailored to the specific company can effectively reduce the volatility of future cash flows with regard to currency fluctuations and make an important contribution to crisis management.