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Hedging policy creation

Hedging Policy | HCFX

Scenario

Our client is looking to external investors to raise money and wants to demonstrate discipline and prudence, even whilst running a high growth business.

With FX playing a large part in their business, a well-documented treasury policy is vital.

We’d been working with this client for a little under a year when they said they wanted to formalise their processes and get their documentation in order.

They’re a fast-growing retail business, with sales in Europe and the US, and manufacturing in the UK, so a lot of currency sensitivity and multiple income streams.

Underlying their desire to get things in check is the need to raise money to continue their growth and probably accelerate it. Their logic – which is completely sound – is that a business with a well-documented strategy and process is probably more appealing to a wider range of investors and could lead to a better valuation.

Roll on a treasury policy…

Solution

We already know the hedging strategy and the process are fit for purpose.

They’re a lean team with a low risk threshold, so they use vanilla forwards with a bit of flexibility built in to give their cashflow a bit of a breather when necessary.

As a growing business, their forecasting isn’t as accurate as they would like it to be, so we allow for that when we come to booking the correct amount of FX coverage.

Their clients pay on a combination of short terms or on a pro-forma basis and they set their budget rate annually, but update their budget rate quarterly if their realised rates deviate by more than 5% from the budget.

With the above information, we’ve already got most of the policy, it’s just a case of documenting it and we’ve done this by following a pretty simple formula:
– Identifying the risks that you face
– Establishing your appetite for each risk
– Agreeing how you manage each level of risk
– Assigning who manages risk, and which counterparties you manage it with
– Reporting on the risk, including: who, how, and what for?

We know that the risk comes from receiving foreign currency income and there being an exposure to the FX market and also a possible variation against the company’s internal budget rates.

We also formalised how they would determine their budget rates, so that no one person could ‘take a view’ on the market that might lead to a chasm between belief and reality.

With fine margins, we know that risk appetite is limited. And that because forecasting isn’t as strong as they would like it to be, we’ll use some of their limited appetite to think about the size of the hedges, rather than taking risk to try and improve the overall rates achieved.

There really is only one level of risk here, as the funds flow is uniformed, so we don’t need to spend long thinking about different situations – but as the business develops, we’ll re-visit this.

The team is small, but having defined responsibilities and sign off is good practice and easy to abide by, so we’ll bring those in.

Reporting on the risks being managed, how the policy is performing and what could be improved – that’s down to us and we do this with quarterly check ins and an annual deep dive ahead of the next year’s sign off.

A good last practice to adhere to is version control. With your policy being a live document, it’s always good to know what previous iterations were and who changed them and why

Implications

Formalising a process that is already effective can feel like a bit of a box ticking exercise.

But by standing back and working on the process rather than within it, there’s often areas you end up questioning and improvements that can be found – particularly when a fresh set of eyes, such as ours, take a look.

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