FX risks are hedged in one way or the other in many companies. In its most basic form, you hedge every single FX position. But you do not have to stop here! Let´s look at an example to demonstrate the advantages of a more rigorous FX risk management approach and how hedging costs can be reduced.
A Spanish clothing retailer with worldwide fashion stores and production facilities has implemented group-wide liquidity planning and hedges FX exposures one-to-one. Operating in nearly 100 countries, the company´s main currencies are EUR, USD, GPB, JPN and MXN. How can the clothing retailer evolve its FX exposure management
1. Simple Many-to-one Hedging
The retailer´s risk manager sums up all USD receipts and uses a single hedge to mitigate the USD exposure. By reducing the number of derivative transactions and increasing transaction volumes costs are reduced. Then, he does the same for receipts in GBP, JPN and MXN as well as for receivables in all currencies.
2. Advanced Many-to-one Hedging
Further evolving the FX risk management approach, the risk manager sums up receipts and receivables for USD, GPB, JPN and MXN and executes a single hedge for each currency. This way the number of hedges can be further reduced, leading to additional savings.
3. FX Exposure Netting
Finally, the risk manager could apply FX exposure netting and consider cross effects. Looking at functional currency pairs, short and long exposures of its subsidiaries can be netted and hedged together, again decreasing costs. To keep things simple, let´s only take a look at the headquarters in Spain and two subsidiaries in the US and Mexico. As the graphics shows, the five exposures are not hedged individually, but summed up and hedged 19,5k USD and -40mn MXN against EUR. The number of external FX trades is reduced from five to two, decreasing total volume from 280k EUR auf 43k EUR. By multiplying this with the pips, you get the net cost reduction.
If you are planning to move ahead and take three steps to evolve your FX exposure management, you have to review your treasury technology as well. As you can imagine, hedging FX exposures at higher levels of sophistication cannot be done with spreadsheets anymore. The retail company´s risk manager will need professional software. Platforms for Treasury and Risk Management (TRM) offer not only capabilities for liquidity planning and FX exposure netting, inclusive of integrated market data feeds, but also analysis and simulation tools, enabling the fashion retailer´s risk manager to better understand risk correlations and effectively cut down hedge costs.
Read our White Paper “How to Align Growth, FX Risk Management and Technology” for more best practices to transform your exposure management.