Board of Director’s checklist for corporate treasury management
Forex Hedging
Updated on: 1st November 2021
The Board of directors has ultimate responsibilities for financial market-related cost savings, profitability enhancement, and risk optimization. Corporates are exposed to forex, commodities, and interest rate risk on a regular basis. Here is a checklist for the board of directors for Fx risk management and on avoidance of Fx loss.
1. Get what’s working well-Best Industry Practices– Board of directors should be aware of the policies, practices, and ideas which top corporates in the industry are following to manage their treasuries especially forex and interest rate exposures. The ideas should be given due consideration and adopted wherever possible instead of quick refusal. Treasury optimization can bring in significant cost savings and profitability enhancement and one of the ways is to pick up from the corporates who are doing it well. When we prepared our presentation on industry-wise and top treasury wise best practices, that (A U B U C) list kind of captured almost all the good practices. If you want to go through the presentation, just put up a request here
2. Knowledge is money – especially true for treasury – Top management should focus on upgrading the knowledge of treasury management including forex, commodities, and interest rates. This is an area where knowledge translates directly into money and hence the BOD investment is worth almost 100% of the time. Practical knowledge up-gradation is required at all levels. Incidentally, our research shows that knowledge up-gradation is needed even at senior-most levels. So do not shy away from understanding some derivatives or some concepts like hedge accounting, value at risk, dynamic hedging, algorithmic hedging as these concepts can prove to be a game-changer. We have trained over 1000 corporate professionals on hedging and risk management including many of the board of directors. Empirically we have seen where senior management is open to learnings, performance is better.
3. Set the rules of the game –It is important to define what is preferred Clearly and Numerically define objectives: For example, an exporting company board should clearly define what will be the benchmark – a) the annual budget rate or b) the costing rate used for order or c) market rate at the time of receipt of funds.
While the objective will be to outperform the benchmark, the target should be realistic. For example, you can outperform the forward level by 2% or 3% on a consistent basis. But targeting a larger number will make the savings inconsistent.
It is important to know the risk-free exposure number i.e. the exposure which if hedged the company will be truly risk-free from Fx volatility. After that- measure the risk and potential benefits; and these are the two parameters you need to optimize to achieve an efficient frontier.
The tolerance level or worst-case levels also have to be fixed to ensure that the company never suffers more than defined and easily tolerable loss.
Other rules like minimum hedge ratio and maximum hedge ratio to be fixed by the board of directors. Use of instruments and ratio amongst instruments. Preferred tenors of the hedge are part of the rules which a director needs to fix. It’s important to understand the implications of every option before making the final decision.
4. Number based monitoring – The director should be monitoring the following numbers on a regular basis.
- Past performance compared to benchmark – including MTM.
- Current value at risk or some measure of the amount of loss the company can suffer if things go wrong.
- Estimated savings in the coming period.
- Hedge ratio and open position – bucketed for months and quarters.
It is important to have an extremely numerical approach for monitoring instead of a subjective assessment approach. Set up a strong MIS approach and do not shy away from demanding all data you need.
5. Review strategy and policy from time to time – Many companies do not review their Fx policy or hedge strategy at the board level for long periods. That is not correct. The policy and strategy should be critically evaluated at least once. Best practices and important changes should be incorporated. The changes need to be expertise based and data-based.
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