Avoid market volatility pitfalls - use an FX expert


Unpredictable, wildly volatile foreign exchange market conditions seem to be established as the normal state of things in today’s economic and political turmoil. Many South African companies with significant import/export business are naturally exposed to FX market fluctuations, which frequently lead to unwelcome volatility in profits and earnings. With today’s emphasis on cost efficiency, companies are torn between budgeting the resources to put an effective FX exposure hedging programme into place or risking a substantial proportion of their revenue.

By Hennie de Klerk, CEO of TreasuryOne

South Africa's exposure to commodity price uncertainty is well known and is amplified by the many troubling issues afflicting the global economy. For example, the course of the Chinese economy is unclear, and India is presently coping with an internal financial crisis driven by currency reforms. This month, the new US administration may start to implement protectionist legislation, the 2017 elections in France and Germany will fuel Eurozone uncertainty, and Brexit will be a continuing source of turmoil for years to come, as no one has any idea of what kind of deal will eventually be resolved after many months of potentially acrimonious negotiations - and it is yet unclear when these will start.

Within this uncertainly, exchange risk management should be a sustained priority for South African CFOs and treasurers.

The FX market itself is subject to the conflicting pulls and pushes of technical, fundamental and psychological forces. Technical forces are supply and demand factors which are driven by monetary events, policy shifts, and significant market movements. Fundamental factors are the underlying economic realities impacting a currency, such as inflationary indices, GDP performance and related factors such as industrial production and employment levels. Psychology comes into play when unexpected events such as Brexit, the firing of a Finance Minister, or the election of an unexpected candidate president enter the fray - and when psychology is dominant, volatility increases and market direction may be the opposite of what common sense might suggest.

Through all of this, corporates must somehow plan and time market interventions to achieve superior pricing over a sustained period if they are to secure a competitive advantage in hedging efficiency, and hence foreign revenue and asset value protection.

Companies can radically improve their exchange risk profile by working with expert third parties to add external strategy design and hedge programme execution services as outsourced complements to their finance operations. This will allow the organisation to design an FX hedging programme that most closely fits the business and the outlook over time for the relevant markets, and which is compliant with regulatory and legal requirements.

Tips for designing an effective programme include:
• It should be tailored to fit the company's particular business patterns and outlook and finance policy, to protect foreign currency profits and earnings over time.
• The third-party partner should recommend instrument combinations and execution timing objectives to optimise results for the organisation.
• The relationship between the client and the treasury services company should be close so that solutions are originated which closely correspond to the actual risks and their resolution priorities.

The benefits of using expert advice include:
• The cost factor - the economies of scale which are available will often outperform the staff and overhead expenses of setting up and operating an effective in-house dealing team.
• The supply of top-class dealers is limited, so it is often better to license the best available execution services when needed, through the right outsourcing partner.

In several ways, the global economic and political outlook is uniquely challenging today, with a new normality of volatility and uncertainty. Working with a complementary expert third party provides a means of eliminating many of the key risks associated with exchange exposures, leading to enhanced finance management though demonstrably more dependable revenue forecasting, and actual performance.

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