The hidden secret behind the different types of foreign exchange exposure

23-11-2021 | treasuryXL | Kantox | LinkedIn

Fresh from leaving the famous Genesis rock band that he helped found, songwriter and musician Peter Gabriel came out with an innovative album called Exposure, where his fascination with electronics and new recording techniques was openly on display. In the eponymous song, he kept on droning the E-word over and over:

Exposure
Exposure
Exposure
Exposure
Exposure

 

At Kantox we share this almost obsessive-like concern. But we care about FX exposure, a very specific kind of exposure. And so do most corporate treasurers: according to the last Kantox & TMI FX Survey, exposure-related concerns are seen by as many as 66% of participants as the most important FX challenge faced by companies.

In this blog we seek to determine the three types of foreign exchange exposure:

  1. Forecasts of revenues and expenditures
  2. Firm commitments for sales/purchase orders
  3. Accounts receivable/payable

 

Understanding the different types of foreign exchange exposure

FX exposure, in a nutshell, is the degree to which a company is affected by changes in exchange rates. To arrive at a precise definition of the three types of foreign exchange exposure, we need to understand the goals set by management in terms of its FX risk management policy.

If the goal is to remove accounting FX gains and losses, then accounts receivable and payable are the key pieces of exposure. If, however, management seeks to protect company cash flows from currency fluctuations, then the relevant type of exposure results from a set of company-specific business parameters.

These parameters include the firm’s sensitivity to FX (as measured by its profit margins and the weight of foreign currencies in the business), its degree of forecasting accuracy, the forward premium/discount of the currencies in which it operates, and several others. But the decisive element to consider is the firm’s pricing parameters.

Steady or dynamic prices? Forecasts and firm commitments

When determining the types of FX exposure, pricing dynamics play a key role. Does the company adjust selling prices after a campaign or budget period is over? Does it attempt to keep prices steady for a set of periods ahead? Or does it price dynamically with an FX rate? (*). Most firms implement one, or a combination, of the following pricing strategies:

Steady prices for individual campaigns/budgets. Some businesses keep steady prices for an entire campaign or budget and adjust them as the following campaign or budget period unfolds, thus incorporating FX fluctuations into the new prices.

⇒ TYPE OF FX EXPOSURE: forecasted sales and expenditures for each individual campaign or budget.

Steady prices for a set of campaigns/budgets. Competitive pressures may lead firms to keep steady prices across a set of campaigns or budgets without adjusting them, even in the face of sharp adverse currency fluctuations.

⇒TYPE OF FX EXPOSURE: rolling forecasts for sales and expenditures across a set of campaigns or budgets.

Dynamic prices. For firms that operate in a dynamic pricing environment, pricing is itself a natural hedging mechanism. FX risk arises from the time lapse between the moment a transaction is contracted and the moment it is finally settled in cash.

⇒TYPE OF FX EXPOSURE: firm commitments for sale and purchase orders

FX management and the types of foreign exchange exposure

This brief overview of the three types of foreign exchange exposure provides the starting point for a well-structured FX management process. Exposure items must be properly collected and processed before hedging programs can be implemented. Risk managers must know with precision how to retrieve, from disparate company systems, the information relating to each type of exposure.

 

Whereas most Treasury Management Systems provide the necessary information in terms of accounts payable/receivable, data about the two other forms of FX exposure —forecasts and firm commitments— are usually scattered between a host of company systems (ERP, CRM, specific software tools) and spreadsheets. This leads to a number of practical problems whose importance is usually underestimated:

  • Can the relevant pieces of exposure be retrieved in a timely manner?
  • Is the information complete and granular enough?
  • Who validates it, and through which processes?

Quite logically, the level of complexity increases in situations where different pricing parameters coexist within the enterprise, many currency pairs are in use, and both accounting and cash-flow related exposures are treated.

Technology to the rescue

The good news for treasurers is that Currency Management Automation allows them to efficiently collect and process the firm’s FX exposure with procedures that eliminate human error and other operational risks. The solution uses APIs to run the end-to-end FX workflow, allowing exposure data to seamlessly flow between different systems —ERP, TMS and others— without any need for spreadsheets.

Treasurers set up their own business rules according to the different types of foreign exchange exposure they need to collect and process, and let technology remove the risks and costs associated with manually executed tasks. With an added bonus: they can remove concerns about the accuracy of their budgeted FX exposure, giving them more time to improve forecasts.

(*) Note that more than one type of price dynamics can exist within the same company — think of heavy machines, spare parts, and services in the industrial engineering space, each with its different pricing criteria. In this case, the type of FX exposure will be different for each business line.

Expert-led Conversation | The Digitalisation of Treasury: Your FX Risk Management toolbox for 2022 | 30 November 2021

treasuryXL | Kantox

 

Date & time: November 30, 2021 at 9.30 am CET | Duration 45 minutes

2022 is just around the corner, and we want to make sure you’re armed with the best technology tools to help push your treasury department to the next level. 

Join Kantox and TreasuryXL in this expert-led conversation on the future of FX risk management and the treasury trends to tap into in 2022.

 

Moderated by Pieter de Kiewit, owner of Treasurer Search, this deep-dive into the evolution of technology in treasury departments and the increasingly strategic role of the treasurer, will bring together insights from industry leaders, including Florin Hica, Head of Global Middle Office and Risk Strategies at ZF Group, Antonio Rami, Chief Growth Officer and co-founder at Kantox and François Masquelier, incoming President of the EACT.

 

The panel will be covering the following topics:

  • Treasury trends towards digitalisation
  • Why your Excel spreadsheet is not enough to manage currencies
  • The changing role of the treasurerThe session will close with a Q&A session.

No More Excuses! It’s Time to Implement the Right Hedging Program

11-10-2021 | treasuryXL | Kantox

More than half the participants of the Kantox & TMI FX Survey describe their existing currency hedging program as inadequate. And that’s not all: 72% of participants admit the need for updates and changes to their policies and programs going forward.

How do we account for this widespread inadequacy? The answer is simple. Most managers start by assessing the available Treasury resources. Only then do they set up the firm’s hedging programs.

This is the wrong approach.

Instead, managers should start by assessing the FX needs of the business, paying special attention to the firm’s pricing parameters. Only then should they design the hedging program.

Over-hedging —the situation of a firm that has hedged in anticipation of an exposure that has failed to materialise— is a perfect example of the challenges posed by a program designed with the available technology. As the Kantox & TMI Survey shows, it is one of the most pressing concerns for treasurers.

The problem of over-hedging is often associated with a ‘lack of visibility’ in treasurers’ forecasts. The apparent solution then is to ask for more staff to be hired at the Treasury team.

At Kantox we disagree with this diagnosis.

More often than not, over-hedging is the byproduct of a hedging program that was badly designed from the start—and where the wrong tools were applied. Spreadsheets, TMSs or ERPs, were never designed with FX management needs in mind.

That’s why it is becoming more and more important to use technology that is flexible enough to allow managers to deploy FX programs that are tailored to the specific needs of the business.

Starting off on the right foot

Take the case of a company that does not update its prices frequently, yet has an FX-sensitive business model, favourable forward points, and a low degree of forecast accuracy. It would be hazardous for such a firm to rely on a traditional ‘static program’ where the whole budget is hedged at the start of the period.

Instead, the magnitude of an early static hedge should be kept within the bounds of what is nearly 100% certain in terms of accuracy. For the rest of the budget, a more dynamic combined program —based on firm commitments— can be designed.

Such hedging programs and combinations of programs can be tailored to fit any business model and pricing parameters. By applying these programs, companies make sure that situations of under or over-hedging are avoided, and that a hedge rate that is equal or better than their budget/campaign rate is systematically achieved.

But this requires technology.

FX Survey

A game-changer: Streamlining the end-to-end FX processes

There is a way out of the costs created by inadequate hedging programs. As Antonio Rami, Kantox’s co-founder and Chief Growth Officer put it during a recent Kantox webinar: “By using technology to streamline the end-to-end process of FX risk management —from the pre-trade phase down to the accounting tasks— companies can sidestep the pitfalls of softwareless currency management”.

Armed with a thorough understanding of the FX needs and pricing dynamics of their business, companies can deploy the Currency Management Automation solutions needed to create —and to execute— the hedging program that best suits the business.

It’s high time to ditch excuses like the ‘lack of visibility’, ‘high FX volatility’ and ‘insufficient treasury resources’.

Start off on the right foot instead. Look at the needs of the business first, and then go for the hedging program that allows your firm to take advantage of emerging growth opportunities—just about anywhere in the world.

Spreadsheet risk: the silent killer of FX performance

07-09-2021 | treasuryXL | Kantox

Imagine a perfectly designed currency hedging program for a company that seeks to protect its annual budget. Given the specific features of that company —especially its pricing dynamics— such a program would allow the finance team to systematically achieve a hedge rate that would be equal or better than the FX budget rate, avoiding overhedging all the while. The hedging strategy would also consider the firm’s degree of forecast accuracy, as well as the forward discount or premium of the currencies in which it trades.

Now imagine that this optimal FX hedging program was implemented on perfectly designed spreadsheets. Armed with super-efficient spreadsheets, the finance team would project forecasted revenues and expenditures, calculate the firm’s exposure to currency risk and set a time frame for the execution of hedges.

A treasurer’s dream come true? Not so fast.

Any reasonably well-designed currency hedging program goes through a process in three phases: the pre-trade phase, the trade phase and the post-trade phase. Each of these phases, in turn, comprises several intricate steps. And here’s where a wholly unexpected risk would sneak in, with potentially devastating consequences: spreadsheet risk, the silent killer of performance.

Spreadsheet risk is omnipresent 

Spreadsheet risk comprises a series of errors stemming mostly from the requirement of data to be manually inputted into each cell. Manual management not only takes up much of the financial team’s resources and time — it makes human error inevitable. The most commonly observed errors and risks comprise:

  • Data input error, including ‘fat finger mistakes’
  • Copy & paste error
  • Formatting errors
  • Formula errors
  • Multiple versions across the firm
  • Lack of backups
  • Users’ lack of skills
  • Insufficient guidelines

spreadsheet risk in FX hedging

Despite all the efforts in spreadsheet risk management, the problem is not going away. In fact, more risk is being created as economies grow and businesses become more complex. The truth is that spreadsheets were originally designed for small pockets of data. They were never designed to handle large amounts of data in an interconnected environment.

Experts know well that the world’s most famous business spreadsheet saw the light of day before the World Wide Web and the internet browser — that is, before the explosion of interconnectedness. And interconnectedness lies at the heart of modern FX hedging programs.

Spreadsheets traveling back and forth

The most prosaic element of a FX program is the seemingly innocuous process of sourcing currency rates for multi-currency pricing purposes. Quite apart from the fact that many firms undertake it with irrelevant time-based criteria, the reality is that, once currency rates are sourced —for example, from the European Central Bank’s website— the commercial team receives the information on a spreadsheet.

Next, the FX exposure needs to be collected and processed. Budgeting, as we know, is a process that involves commercial and production teams, purchasing managers, economists, human resources departments and treasury teams. In other words: the cornerstone of the hedging program is the result of dozens, or more likely, hundreds of spreadsheets traveling back and forth across the enterprise. At this point, spreadsheets risk is only in its initial stages.

Depending on the forward discount/premium of the currencies involved, conditional FX orders are set. The information must be provided by the relevant commercial teams/purchasing managers — on a spreadsheet. Then the trade phase kicks in. If manually executed, several processes take place: approval request, first review, second review, final approval. Yet more spreadsheets are transferred in the process.

And what about the FX payments and collections process? And the FX accounting and performance analytics stages? You guessed it: critically important information is subject, once more, to data input errors, copy & paste errors, formula errors and formatting errors. These are the ingredients of a potentially nightmarish scenario. Even for the best-designed currency hedging programs. And even for programs implemented on brilliantly designed spreadsheets.

FX Automation: taming spreadsheet risk

In an increasingly interconnected world with more complex business models, spreadsheet risk can be a silent killer of performance. Business managers face enough risks in the day-to-day management of their operations, and treasurers in particular have enough on their plates to worry about the spreadsheet risk in their FX hedging programs.

It’s high time they work to better manage this risk. Here, Currency Management Automation is your company’s best antidote. These software solutions use Application Programming Interfaces to ensure that data can flow seamlessly between different systems (ERP, TMS) and software without any need for spreadsheets.

The time to act is now.

The real value of Multi-Dealer FX trading platforms

16-08-2021 | treasuryXL | Kantox

(Spoiler: it’s not about trading costs)

A few years ago, PwC consultants proposed a clever analogy to illustrate the difference between single-dealer platforms (SDPs) and Multi-Dealer Platforms (MDPs). For banks looking to provide products and services to corporate clients on a platform, SDPs are like an airline’s website, where high-margin sales occur. Multi-Dealer Platforms, in turn, are the equivalent of online aggregators that let customers compare fares and schedules. While the former emphasizes customer relationship intimacy, the latter work as “transactional supermarkets” with a higher degree of automation.

When it comes to the corporate FX market, where spot and forward transactions take the lion’s share in terms of traded volumes, Multi-Dealer Platforms like 360T and SWAPs have been the venue of choice. The shared technology of Multi-Dealer Platforms has enabled them to better adapt to changing customers’ needs than the proprietary technology of most Single-Dealer Platforms. As a result, corporate treasurers have moved en masse to Multi-Dealer Platforms to improve FX trading processes and reduce spreads. As Kantox’s CEO Philippe Gelis argues, the success of Multi-Dealer Platforms has resulted in a spectacular “compression of FX spreads for vanilla products”.

Beyond trading costs: the value proposition of Multi-Dealer Platforms

Lower FX trading costs, the natural result of the Multi-dealer platform proposition, play an important role by facilitating the participation of firms who see a benefit in ‘embracing currencies’ to access new markets and grow their business. But the fixation with lower spreads is unwarranted. Going forward, treasurers will care less about paying 9 bps instead of 10 bps, if a 2% move in the exchange rate can be easily and efficiently handled by an automated hedging program.

To see where the real value of Multi-Dealer Platforms lies, let us start by briefly looking at the three phases of the FX hedging workflow: pre-trade, trade and post-trade.

The pre-trade phase involves sourcing exchange rates for the purpose of pricing as well as capturing and processing the relevant exposure. Once the FX trade is executed and confirmed, the post-trade phase kicks in with reporting and performance analytics as well as accounting and payments and collections.

In this increasingly automated series of steps, MDPs play a key role. Kantox’ partnership with 360T, for example, provides straight-through processing integration for corporates of all sizes to tailor their Multi-Dealer Platform setup to execution and routing rules of their own making. The range of functionalities includes:

  • Trading in spot, forwards, NDFs and swaps with hundreds of liquidity providers
  • Automated trade and data requests via API
  • Transparent pricing with greater efficiency in sourcing
  • Diversification in order to lower counterparty risk
  • Ability to select preferred liquidity providers
  • Complete trade history and audit trail
  • 24/6 execution capabilities
  • ‘Best price execution’ functionality that puts liquidity providers in competition with one another
  • Conditional orders setup with order management tools
  • Automated trade confirmation by API or email

What emerges from this picture is clear: the ‘trade phase’ of the FX corporate workflow is being automated at lightning speed. The reduction in spreads, while important, only tells part of the story. The real value proposition of a Multi-Dealer Platform lies elsewhere: they are an integral part of the seamless, end-to-end management of corporate currency workflows that Currency Management Automation solutions provide.

This process of automation comes with an added bonus: Application Programming Interfaces (APIs) ensure that data can flow seamlessly between different systems (ERP, TMS) without any need for spreadsheets, reducing spreadsheet risk and freeing up valuable treasury resources.

When viewed in this broader dimension, as part of a larger process that includes all the phases of an automated FX hedging program, Multi-Dealer Platforms are part of an ecosystem that allows companies to benefit not only from automating, one by one, the different phases of a hedging program but to have all these processes integrated with one another, thus creating more value than the sum of the parts.

GO TO PARTNER PROFILE

Press release | Kantox joins the treasuryXL community as Premium Partner

28-07-2021 | treasuryXL | Kantox

treasuryXL announces partnership with Kantox to strengthen dissemination of the latest trends about currency management automation technology

VENLO, The Netherlands, July 28, 2021 – treasuryXL, the community platform for everyone who is active in the world of treasury, and Kantox, the global leader in currency management automation software, today announced the signature of a premium partnership.

This partnership will create a new content resource for the treasuryXL community. Treasurers will now have access to a regular stream of insightful and practical content on currency management automation. This partnership includes:

● Collaboration on messaging, content production, and visibility
● Mutual distribution on select items of interest
● Collaboration on larger themes: event promotion, speaking and experts contribution, publications

Through this partnership, treasuryXL and Kantox are striving to ensure that treasurers are always up to date with the latest news and events in their field.

About treasuryXL

treasuryXL started in 2016 as a community platform for everyone who is active in the world of treasury. Their extensive and highly qualified network consists of experienced and aspiring treasurers. treasuryXL keeps their network updated with daily news, events and the latest treasury vacancies.

treasuryXL brings the treasury function to a higher level, both for the inner circle: corporate treasurers, bankers & consultants, as well as others that might benefit: CFO’s, business owners, other people from the CFO Team and educators.

treasuryXL offers:

● professionals the chance to publish their expertise, opinions, success stories, distribute these and stimulate dialogue.
● a labour market platform by creating an overview of vacancies, events and treasury education.
● a variety of consultancy services in collaboration with qualified treasurers.
● a broad network of highly valued partners and experts.

About Kantox

Kantox is a leader in Currency Management Automation software that enables corporates to effectively manage their FX workflow and leverage currencies for growth. Since 2011, Kantox’s expertise and solutions have allowed businesses to collect FX exposure data and automate their hedging, pricing, payment and collection processes.

The company is headquartered in London and authorised by the Financial Conduct Authority (reference number 580343) and Kantox European Union, S.L. is based in Barcelona and authorised by the Bank of Spain (reference number 6890) For more information, visit www.kantox.com, @Kantox LinkedIn.

 

GO TO PARTNER PROFILE