“An effective hedging program does not attempt to eliminate all risk,” wrote Ian Giddy, professor of finance at New York University’s Stern School of Business. “Rather, it attempts to transform unacceptable risks into an acceptable form. The key challenge for the corporate risk manager is to determine the risks the company is willing to bear and the ones it wishes to transform by hedging.”
But how can you know what risks require hedging without understanding the dangers a company is exposed too? Far too many hedging programs target nominal risks rather than a company’s net exposure. Many companies will look at their foreign exchange (FX), trade and commodity exposure all separately, whereby different tools are all measuring different types of risks – a process which can negatively impact a business’s ability to see the bigger picture.
Thankfully, corporate treasurers and risk managers are investing in and gaining access to technology solutions that can better identify net economic exposure and optimise their end-to-end risk management activities.
Advanced data analytics
There have been significant technological advancements in data analytics over the past couple of years. Tools like data mining and data lakes are helping treasurers and risk management teams to delve into their supply chain systems and extract relevant information to better understand their exposures and inform their hedging strategies, says Karlien Porre, treasury advisory lead at Deloitte.
These same tools can also be applied to companies’ procurement systems, which automate the purchasing of goods and maintain inventories, to better understand and potentially flag exposures coming down the pipe.
On a more granular level, there are solutions like AtlasFX which can lift the lid of enterprise resource planning (ERP) systems and extract data that can help treasurers and risk managers identify their FX and commodity exposures to manage them more effectively than ever before.
AtlasFX is a cloud-based solution that assists in capturing transaction currency exposures concealed inside corporates’ ERP systems regardless of which software program the company uses, making its integration and implementation simple. And with corporates often laden with old, antiquated legacy IT systems, plug and play software like AtlasFX is extremely attractive for corporate treasurers and risk managers, who often have make a strong case to get capital expenditure approved to invest in hedging technology.
This is just one example of how a technology like data mining can be used in conjunction with other technologies such as ERP systems to help corporates manage risk and develop effective hedging strategies.
“The whole approach to data mining and data lakes is something that really could revolutionise and certainly simplify and improve companies understanding of their exposure across the whole ecosystem,” says Porre.
Understanding the spectrum
There are many different forms of hedging tools and technologies in the market to help corporate treasurers identify risks and inform their hedging strategies. But to choose the right one depends on the maturity level of its treasury and risk management function within the business.
On a basic level, you could have a company running excel that will be populated by data comparison systems. At the other extreme, companies that run in the commodity trading space or that are more complex or sophisticated might have built their own in-house systems instead. Other companies may use external tools and platforms. But ultimately, it really comes down to what works best for a company based on its hedging strategy, which will determine the type of technology it invests in.
At the lower end of the technology spectrum are treasury management systems like Salmon Software, which first burst onto the scene in 1985 and offers corporate treasurers everything from cash management and cash forecasting tools to dealing and intercompany solutions. At the higher end, there are systems like FIS Quantum, a cloud hosted treasury management solution that is sophisticated and easy to use.
It helps organisations throughout the world manage their cash, debt and investments, as well as assess and manage various types of risk, including currency and adjustments in interest rates. And then sitting somewhere in the middle of the pack are treasury management systems like Kyriba, which offers a range of modules covering everything interest rate derivatives to bank fee analysis, and SAP, a German multinational software corporation that makes enterprise software to manage business operations and customer relations.
But what characteristics determine where a software solution sits on this spectrum? The complexity of the functionality it can deal with is one, as is the various types of hedging instruments it can utilise.
“Simpler tools may not be capable of dealing with complex options trading for example,” says Porre. “While the complex systems will allow risk managers to tailor and configure hedging strategies to the needs of a company and deal with a wider variety of hedging instruments.”
Another characteristic to consider is whether the software is an “off the shelf solution” which are often simple, but do not allow for a bespoke experience to meet the demands of an individual organisation. A more advanced solution may allow for a good degree of customisation, but the trade-off is that the system will require more effort and a greater cost to implement.
Other metrics that define the sophistication of a hedging technology solution include the volume of data flows and transactions it can cope with and how many users can use it simultaneously – all of which should be considered by corporate treasurers and risk managers before pulling the trigger and investing.
Hedging in a global pandemic
The coronavirus pandemic brought unprecedented levels of volatility across global equities, FX and commodities, with corporate treasurers, risk managers and the technology that underpins their hedging strategies all put to the ultimate test.
And while this latest economic shock is unlike any seen in over a century and its full size and scale still not clear, the strength of corporate hedging programs will determine how effectively companies will weather the storm by effectively reducing the cost of capital and stabilising earnings.
“Market shocks, whether that be a global pandemic like the one we are facing now, or major fluctuations in the value of a specific currency for example, happen all the time,” says Paolo Esposito, director and treasury advisory at Deloitte UK.
“Some companies taking more of a reactive approach to risk management are more likely to be caught off guard by market shocks and therefore will likely have hedging strategies that are less responsive.
“Other companies may have a more proactive approach. It really comes down to how mature companies’ overall approach is to risk management, which will ultimately determine how they utilise technology to insulate their company from market shocks.”
As companies around the world adjust to this new normal and attempt to recover from the economic fallout from coronavirus, those that boast a mature approach to risk management combined with an investment in technology solutions to identify exposures will have a major advantage. Those that chose to ignore the importance of effective risk management, however, may not survive.