Our client is a UK PLC with subsidiaries in Japan, India, the US and Scandinavia. Sterling is their functional and reporting currency, though operationally they deal in local currencies – both income and expenditure. The client has a legacy hedging policy that was written at the time of IPO which the treasury team was falling short of what they wanted to achieve. The board wanted an external opinion before making a decision.
Annual turnover of the business c.£400m, of which 60% is derived in foreign markets. Current hedging policy restricted hedging past six months and for any more than 50% of a known FX exposure.
by netting directly between currencies, we reduced unnecessary FX trades by 3% of turnover
By scrutinising their forecasting, we were able to justify doubling their permitted hedge duration and hedge percentage, giving them more price stability for longer
Annual turnover of the business c.£400m, of which 60% is derived in foreign markets. Current hedging policy restricted hedging past six months and for any more than 50% of a known FX exposure. Derivatives were allowable but currency options were prohibited. Any hedge greater than £500k had to be signed off at board level.
As a mature business in a market not immediately prone to disruption, the client was happy with the accuracy of their operation cashflow forecasts to 12 months and a strong sense of the 12- to 18-month timeline, all things being equal.
Capital expenditure was factored into the annual budget (whether allocated or not) but there was no specified foreign exchange considerations.
A budget rate for each currency pair was set at the start of the financial year and communicated to the sales teams. This rate remains static.
We modelled the cashflows based on their forecasts and enforced as much natural hedging as possible before looking at surplus and shortfalls in each currency – netting currencies directly with each other wherever possible, rather than reverting to GBP functional currency. Shortfalls greater than £50,000 per month were identified as being ‘hedgable’ and were therefore included in the hedging programme. This programme progressively built hedges through regular forward contracts, bringing near dated forward cover (0-2 months) to 90% of forecasts and longer term liabilities (10-12 months) at 20% of forecasts, being progressively built up as the liability came closer to the present.
Communication of ‘real’ FX hedge rates to the sales teams has allowed for more accurate pricing of tenders and less conflict between sales and finance functions as each has a better understanding of the process, and realities of what is achievable.
Capital expenditure – any significant cap-ex spend (>£100,000) as a ‘special project’ and hedge on a case-by-case basis. Smaller amounts can be drawn from existing hedges where available, unless it will utilise >50% of available hedge.
Options and derivatives were not deemed necessary for the processes and excluded from policy.
The team now have a treasury policy that is fit for purpose and measurable both internally and externally. Communication of ‘real’ FX hedge rates to the sales teams has allowed for more accurate pricing of tenders and less conflict between sales and finance functions, because each has a better understanding of the process, and realities of what is achievable.
Understanding where and when the business is spending and generating cash.
Identifying currencies that can offset each other, without needing to repatriate to the functional currency. Saving time, money and complexity.
Bench-marking and Monitoring
This policy can be quantified against the previous policy for effectiveness and can be refined and tweaked to fit future changes.
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