Why Is Foreign Exchange Risk Management Essential?

    For businesses operating across borders, it is a priority to assess the degree of Foreign Exchange risk that the organization is exposed to. Ignoring FX management is one of the most expensive mistakes a company can make. Increased trade flows, outbound M&A growth opportunities, expansions, and access to foreign currency (FCY) borrowings subject corporations to fluctuating FX rates. Impacting different areas of the balance sheet and cash flows in various ways, quantum, and frequency, these activities can have a material impact on a company if they aren’t managed properly.

    What is FX Risk Management?

    Foreign Exchange Risk Management policy, also known as FX Hedging Strategy, refers to any of the measures devised by companies or investors to shield the value of their cash flows, assets, or liabilities from unfavorable exchange rate fluctuations.

    The markets are constantly changing, and volatility can have a significant impact on your company’s bottom line without warning. Without an FX risk management plan, you will only be able to act after the damage has been done, and some of your initial response time will most likely be spent strategizing on how to respond properly.

    Why do you need a Foreign Exchange Risk Management policy?

    In the absence of an FX management policy, a business is unprepared to control the possible negative consequences of currency movements, which could result in higher costs, decreased market share, and lower profit margins. Companies should develop and document a policy statement that outlines the company’s attitude, goals, and acceptable responses when handling FCY foreign currency exposures in order to prevent these negative outcomes.

    How to build an effective FX risk management policy

    An effective policy requires a clear corporate strategy and objectives. It should begin with the identification of what key metrics can demonstrate the successful execution of a strategy to its stakeholders.

    It should include:

    • Your business’s foreign exchange risk capacity and timeframes.
    • Risk mitigation tools your organization will use.
    • A company’s decision-makers for FX risk.
    • A robust system for managing currency risks on an ongoing basis.
    • Strategic planning over the long-term (as opposed to daily developments).
    • FX risk management measures and actions that can be shared with a team so the burden is not solely on one individual.

    Recognizing that reducing currency volatility to zero is both unrealistic and impossible, FX managers must prioritize the risks and implement a policy and strategy that aligns with the corporate’s target goals, view, risk tolerance, and budget.

    If businesses and the operating environment transform, so should risk management policies to ensure they are fit for purpose and contribute to the maximization of shareholder value.