Currency volatility looms as US corporates still face uncertainty

The original version of this article first appeared in The CFO on the 29^th of August 2023.

Foreign exchange (FX) risk management has risen to the top of the agenda for many senior finance decision-makers at corporates throughout 2023.

Although volatility has decreased in recent months, it is still a persistent threat due to a combination of rising interest rates, high inflation and geopolitical uncertainty.

This is particularly the case for North American firms transacting in the US dollar. Having slid to a nine-month low in February 2023, it rebounded slightly before once again falling to its lowest level in more than a year in recent weeks.

Fluctuations in the US dollar have had a major impact on North American firms who, according to Kyriba’s July 2023 Currency Impact Report, reported $21.24 billion in FX headwinds in Q1 2023 – up 45% from the same time last year.

While firms are likely to welcome the recent drop in FX volatility, it is vital that they don’t become complacent. With uncertainty set to stay, we believe corporates need to adapt their FX risk management strategies to stay ahead of the curve.

The shifts in hedging practices

According to MillTechFX’s own 2023 CFO FX survey, over two-thirds (68%) of North American firms have experienced heightened FX risk as a result of US dollar volatility.

CFOs are adapting their hedging strategies to make sure this risk is managed as effectively as possible, typically hedging a higher amount of their exposure to increase their protection. Our survey found that the average hedge ratio was between 60% - 69%, with nearly eight out of ten (79%) corporates citing this as higher compared to this time last year.

Similarly, rather than using long-dated FX forwards of up to two years, many are now locking in rates of six months or less with the average length of hedges at five and a half months. This suggests that corporates are opting for shorter hedge lengths to add an extra layer of nimbleness and flexibility should the market move against them, enabling firms to adjust their exposure if they need to.

About three-quarters of firms report that the cost of hedging has increased over the past year. This means that looking ahead, corporate treasurers may consider balancing the cost of hedging against the risk of not hedging and the potential impact this may have on the bottom line.

From past to present

Despite the renewed focus on managing the threat of currency movements, many firms still lack the necessary tools and infrastructure to mitigate this risk, with a third rating their FX set-up as below average or worst in class.

One of the main reasons for this is the persistence of manual legacy systems which can be extremely cumbersome and inefficient. Our survey found that 40% of corporate treasurers have to manually send or upload files for instructing financial transactions, with 35% relying on phone and 34% on email.

FX price discovery can often involve multiple phone calls, e-mails or online platforms to log in to just to get a quote from your counterparties. If its best rate wins, because the market moves by the half second, price discovery requires a team of people; calling, e-mailing and logging in simultaneously before they can collectively decide who offered the best quote.

Price discovery is just the first step in the FX booking process. After a rate is booked in, trade confirmations usually arrive by e-mail. Settlement must then be processed, payment details entered and checked and approval from different layers of seniority can be required.

All of this internal, manual and siloed communication is extremely inefficient. And this is just for one, single trade. Many organizations execute tens or hundreds of trades every month with different products and mechanics, making the entire process a huge drain on time and resources. Corporate treasury teams spend on average 2.31 days per week on FX-related matters, while 72% have three or more people tasked with FX activities.

It is therefore unsurprising that many firms are seeking to embrace digitization to improve operational efficiency, with 81% of corporate treasurers looking into new technology and platforms to automate their FX operations.

How MillTechFX can help

Much of the recent focus has been on whether volatility will resurge during the second half of 2023, but the more important factor at play is the uncertain economic outlook itself.

Hedging currency risk is one of the primary ways that firms can mitigate the risk posed by this uncertain climate, and while there will always be some that don’t hedge their FX risk at all, many are now considering doing so to protect their bottom lines.

MillTechFX by Millennium Global’s FX-as-a-Service model helps corporates and global businesses significantly reduce both FX costs and operational burden associated with FX execution and rolling hedging requirements.

We provide an end-to-end solution, from onboarding with up to 15 counterparty banks to execution, settlement and reporting of FX transactions, including TCA, across multiple funds.

Get in touch today to find out more.