Currency Pulse #22 - Unlocking Growth

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Unlocking growth: French wine 

According to The Economist, roughly 10% of French people drank wine every day in 2022, down from half in 1980. And it’s not only ‘rough’ wines that are concerned. Plus de bulles Champagne notes that champagne consumption has declined in France by 4 million bottles per year, on average, over the last 16 years. 

“Back in 1960 the French drank an average of 116 litres of everyday wine per person. Between 2000 and 2018 that shrank from 28 litres to just 17. The government allocated €200m to buy superfluous low-end wine that producers could not sell” — The Economist

Export markets provide a bright spot. Champagne producers, for example, can count on an average increase of 3 million bottles per year in overseas shipments over the last 20 years, even though competition from crémant and prosecco remains quite intense.

To secure the benefits of international expansion, however, wine exporters need to ‘take ownership’ of the underlying FX risk management process (*). This entails two main objectives in terms of currency hedging programs:

• Primary objective. Layered FX hedging programs achieve a smooth hedge rate over time. This allows firms to protect their competitive position even in the face of adverse moves in currency markets. 

• Secondary objective. Delaying hedge execution with the help of conditional FX orders makes it possible for treasurers to reduce the cost of hedging, as EUR trades at a 1.82% annual forward premium to USD.

(*) For details on how to capture FX markups by selling directly in USD, and how to reduce FX trading costs, see our report: L’automatisation de la gestion des devises pour l’industrie du vin.

EACT Summit 2024: Two Great Sessions

During a ‘Breakout Session’ at the EACT Summit 2024, Nicolas Marquet, Head of Sales for Europe, performed a live product demonstration of Kantox In-House FX. Nicolas showed the flow of internal FX orders between headquarters and subsidiaries—as well as other features like bookholding and back-to-back.

“Kantox In House FX allows headquarters to act as the liquidity provider at group level, providing 24/7 access to FX liquidity to subsidiaries—with customisable markups and validation rules based on tenor, amount, timing and currency pair” — Nicolas Marquet

Another impactful session was moderated by Treasury Management International’s Eleanor Hill. An amazing data point struck the audience: thanks to internally developed AI tools, Dutch semiconductor manufacturing company ASML was able to improve the accuracy of its USD exposure from 70% to over 96%.

Even more remarkable, ASML’s Jeroen van Hulten stressed the fact that few internal stakeholders were involved in the forecasting process—after all, algorithms looking at the past do not need inputs from purchasing managers or economists (see the TMI article on ASML’s forecasting feat).

At Kantox we hold the out-of-consensus view that the importance of super-accurate cash flow forecasts is overstated in FX management. This is because automated hedging programs —and combinations of programs— can achieve a high standard of precision on their own, even with less-than-perfect forecasting accuracy (*).

(*) For more explanations, see our report The CFO’s Guide to Currency Management. 

FX Centralisation: A New Report 

The centralisation of treasury operations is one of the defining stories of our time. It is well told by Justin Callaghan, CEO of Dublin-based FTI Treasury. Treasury centralisation is driven by a combination of knowledge, regulation and technology.

“Treasury is no longer a physical thing, it’s made up of bits and bytes and information, making its concentration much easier than before” — Javier Ibars Gilart, Nestlé 

FX risk management centralisation is an integral part of this move. Two conditions are necessary for a centralised approach to FX risk management:

(1) The execution of external FX trades is the sole responsibility of Headquarters

(2) Consolidated FX policy is set by Headquarters for the entire group

To secure the benefits of FX risk management centralisation at subsidiaries and headquarters, companies need to upgrade their capacity for API-centred automation. The good news? These tools are readily available.

‘AD Tech’ German company

A Supply Side Platform (SSP) based in Germany provides content providers, publishers and broadcasters with technology and services to monetise their premium inventory while optimising their advertising strategy.

Working with media owners around the world, the SSP is active in Europe and the U.S. The finance team manually hedges the firm’s USD-denominated foreign exchange exposure. It does so in an unsystematic way, with two ideas in mind:

• Selective hedging. Hedging relies on the premise that the firm’s managers can beat the market using intuition to adjust the timing and size of positions in FX derivatives.

• Volatile hedge ratios. Hedge ratios —that is, the proportion of the exposure that is hedged— display above-average variability both in terms of size and timing.

This strategy exposes profit margins to FX fluctuations and generates a high number of administrative tasks for the finance team. To reduce FX-induced net income variability, the company implemented Currency Management Automation solutions to:

• Remove FX gains and losses. Thanks to automation, the SSP has drastically  reduced FX losses to 0.03%.
• Scale up the business. With full performance traceability, the company was able to focus on growth and scale internationally by using more currencies.

FX Knowledge Hub. Market-driven vs time-driven

The notion of market-driven and time-driven processes is especially relevant when hedging forecasted revenues and expenditures. It also provides the opportunity to clarify some of the differences between static and layered hedging programs:

• Market-driven or ‘static’ hedging. To the extent that these programs rely on conditional orders to protect a worst-case-scenario FX rate for individual campaigns/budget periods, trading patterns are determined by moves in currency markets.

• Time-driven or ‘layered’ hedging. Layered hedging works ‘like a clock’. Here, the schedule of hedges is known in advance and has to be executed precisely, according to a predetermined calendar of trades.

Note that elements of a market-driven approach can be used in layered hedging as well. When secondary objectives call for minimising the impact of unfavourable forward points, conditional orders can be set on each layer of the FX hedging program.

This makes it possible to delay hedge execution and obtain a better FX rate. But there’s a catch—this procedure requires a significant degree of automation (see: “Lessons from Netflix and Swatch”). 

The BIS on FX markets: 4 points

The Bank for International Settlements discusses the impact of central bank intervention in currency markets on corporate risk management. Four points caught our attention:

1. The carry-to-volatility ratio. Currencies with a low ‘carry-to-volatility ratio’ like CLP may be vulnerable to episodes of market dysfunction. In contrast, higher ratios in MXN and BRL make them more resilient against the USD dollar.
2. Non-Deliverable Forwards. Trading in Non-Deliverable Forwards (NDFs) is becoming more electronic: "Dealers are increasingly pricing and executing FX swaps and NDFs with clients electronically." (We see this every day at Kantox). 
3. Moral hazard. FX intervention creates the perception that central banks can insulate companies from the task of managing FX risk. This may hinder the development of currency markets and instruments—and may lead firms to neglect currency risk management.
4. Internationalisation. Trading in EM currencies has become more international, i.e. involving at least one counterparty that resides outside the issuing country. The median EM currency was ‘internationalised’ at 83% in 2022. Embracing currencies, anyone?

Five Useful Links

1. Amazon CEO’s letter to shareholders. While Free Cash Flow rose to $35.5B in 2023 (up $48.3B), the most impactful part of Andy Jassy’s Letter to Shareholders discusses: (1) a relentless focus on ‘sharp pricing’; (2) Amazon’s global expansion; (3) the firm’s patience in building primitives; (4) GenAI as the next source of breakthrough primitives. 

2. Out of Africa: cratering currencies. A gloomy Bloomberg article assesses the situation in Africa, where major global corporations such as Bayer AG, Nesté SA and Unilever Plc have reduced operations. Among their concerns: “cratering currencies”, including ZAR and KES. 

3. Japanese firms and JPY weakness. While the fall in JPY has boosted the value of exports, the volume of shipments has not benefited as much. According to the manager of an exporter of chemical products: "Our sales appear to be boosted due to the impact of a weak yen, but there's no recovery in terms of volume."

4. China & the global monetary system. Writing for the Financial Times, Russell Napier argues that, as China moves towards “monetary independence”, it will soon put an end to its exchange rate targeting policy. Serious consequences would ensue—although perhaps not the destruction of the international monetary system as envisaged by Mr. Napier. 

5. New Zealand’s CBDC. The Reserve Bank of New Zealand announces consultations for a central bank digital currency. “Digital cash” would be mainly used for payments by individuals and businesses. It could be swapped 1:1 with physical cash using a digital wallet, payment card or phone app—without the need for a commercial bank account.

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