Currency Pulse #2

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Risk & Return: forward points.

CHF is arguably the world’s strongest currency. Solid and long-held governance traditions —including an independent judiciary, a free press and an independent central bank— underpin confidence in the Swiss franc. Safe-haven inflows further underpin its strength during global economic and political turmoil episodes. 

Add to this mix the sharp rise in interest rates in the US and Emerging Markets and you end up with the Swiss franc’s heavy forward premium against USD and many other currencies. Yet, this success creates uneasiness in some corners of the financial world.

In May 2023, hedging USD-CHF for one year implied a cost of carry of close to 3.6% compared to 1% in January 2022. Talk of an increase! Companies that deal with CHF’s forward premium find relief in Currency Management Automation.

Across the entire FX workflow, automated solutions help firms effectively address the concerns posed by the strong franc. See our report Tackling the Swiss Franc’s heavy forward premium.

 Mini-case study: European Telecom equipment provider.

We backtested a hedging program to protect the budget rate of a medium-sized European telecom equipment provider. The company’s FX exposure is on the contracting side, mostly in USD. This means that interest rate differentials are ‘favourable’ as hedging automatically generates net FX gains.

We backtested two hedging programs between 2018 and 2022. In both programs, the budget rate is protected with conditional orders as markets are monitored 24/7 and the exposure remains under active management throughout. These programs are combined with a micro-hedging program for incoming purchase orders.

In one case, 50% of the forecasted exposure is hedged as the budget is set, while no initial hedges are executed in the other. Finally, these two strategies are compared with a no-hedging policy. 

Here’s a useful takeaway: the treasury team must strike a balance between the degree of forecasting accuracy and the expected positive forward points impact. The higher the degree of confidence in forecasts, the higher the size of the initial hedge, and the more significant the financial impact of favourable forward points.

Taking the difference between the average spot market rate at inception and the average hedge rate resulting from the strategy, both FX hedging programs handily beat the no-hedge strategy. Only in 2020, with the sharp decline in USD, did the no-hedge policy produce a better result.

Thus, on a €150 million exposure, the average annual forward points impact was:

• + €1,182,000 → with strategy b
• + €921,000 → with strategy c
• and €0 → with strategy a

It is up to the treasury team to assess the most convenient strategy. Flexibility is the norm.

A spectacular FX data input error

All Nippon Airways (ANA Holdings) mistakenly sold sharply discounted tickets for international flights, as airfares were listed incorrectly on its Vietnam website due to an erroneous currency conversion, according to Bloomberg. A Jakarta-Tokyo-New York-Aruba round trip, normally costing $16,300 went for as little as $890.

Manual data input errors, very frequent with spreadsheets, can be hazardous for both your financial and reputational health. As you manage currencies, the best way to tame spreadsheet risk is to use APIs throughout the FX workflow, all the way from pricing with an FX rate to reporting and analytics.

(*) Thanks to Lucas Miravalls for pointing out this story to us. 

European Association of Corporate Treasurers Survey

The EACT Treasury Survey 2023 is out. Unsurprisingly, cash flow forecasting is seen —for the next 12 to 24 months— as the #1 priority by 43.8% of 250 group treasurers sampled across Europe. In terms of treasury tech, Data Analytics and APIs come ahead, confirming treasurers’ “greater appetite” for new solutions.

Commenting on the results, François Masquelier, Chair of EACT, writes:

“Crises have crystallised the need to digitise and accelerate the ongoing transformation.”

We couldn’t agree more. Surveys are an extremely useful tool — especially when they provide reliable continuity over the years as in this case. 

Yet, we may emphasise another point. Presenting the information by separately grading each individual concern may create the impression of a siloed approach as if liquidity management issues can always be neatly separated from other treasury tasks.

But what if buying and selling in more currencies —thanks to effective currency hedging (concern #5)—, reduces the risk on accounts receivables and leads to extended paying terms from suppliers? Would that not contribute to working capital optimisation (concern No. #2)?

Or take delayed FX hedge execution. Favoured in the event of ‘negative’ forward points when protecting the budget rate, delayed hedge execution is made possible by setting conditional FX orders with static and dynamic stop-loss/take-profit levels.

This approach gives treasurers more time to update their cash flow forecasts (concern #1), as firm sales/purchase orders are automatically hedged. It also highlights the difficulty of neatly separating risk management from cash flow forecasting.

Seen in this light, it is no surprise that ‘Treasury Technology Infrastructure’ —which is required, among other things, to implement automated FX hedging programs— features as one of the top-three concerns in EACT’s extremely informative survey. 

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