Currency Pulse #17 — FX & the Ascending CFO

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According to Fortune Magazine, it’s a good time to be a Chief Financial Officer with designs on upward mobility. During the first half of 2022, approximately 8.1% of 681 CFOs among both Fortune 500 and S&P 500 companies were promoted to the role of CEO—an all-time high. A decade ago, that number was just 5.6%.

But there's a twist. While promoted CFOs achieve higher levels of profitability during their early years on the job, too many "fail to shift their focus beyond the bottom line and eventually lag behind people who came from other roles". The likely reason is clear: "Where CFOs are most comfortable is in the cost end of the business, not driving the top line".

So here’s an intriguing proposal for CFOs: why not use FX management as a way to reconcile risk management and growth? Our Currency Management Priorities for 2024 report outlines the growth benefits of ‘embracing currencies’, once the finance team ‘takes ownership’ of the underlying FX risk: 

• Open up new markets. Sell in more currencies and open up new, lucrative markets
• Increase direct sales. Cut out intermediaries with direct, high-margin sales on the firm’s websites
• Bypass FX markups. Make your product more attractive by avoiding FX markups from your clients
• Boost conversion rates. Increase conversions by using currencies to price better than competitors
• Boost sales-to-assets. Price with the forward FX rate to enhance the firm’s competitive position
• Reduce credit risk. Reduce the credit risk in receivables by selling directly in your customers’ currencies.

Bi-Weekly Back Test: Austrian E-bikes company (*)

Our bi-weekly backtest concerns an Austrian producer of holiday, city and trekking E-bikes. The firm is exposed to the fluctuation of several currency pairs on the purchasing side: EUR-USD, EUR-JPY and EUR-SGD.

The company is currently running a hedging program to smooth the FX rate over time. While this program is achievable with manual execution, the finance team faces two different pain points. On the one hand, it desires to further reduce the average ‘cliff’ between hedge rates.

This would allow the firm to keep prices as steady as possible, for as long as possible. On the other hand, the treasury team is keen to achieve savings in terms of forward points. The proposed solution is a combination of automated hedging programs with the following characteristics:

• Granularity. Apply a more granular layered hedging program. The aim is to reach management’s desired hedge ratios over time, but far more gradually than with the current setup.
• Micro-hedging of firm orders. Add a micro-hedging program for incoming firm orders. This increases the precision of the FX hedging, as forward contracts are executed on the back of firm orders.
• Multi-dealer trading platforms. Take advantage of the ‘best price execution’ that puts liquidity providers in competition with one another, reducing bid-ask spreads.

The layered hedging program increases the degree of ‘smoothing’. It also provides sizable savings in terms of forward points on JPY-denominated purchases, as EUR trades at a 3.5% oner-year discount to JPY, and at a smaller discount to SGD.

Needless to say, the proposed combination of programs requires a high degree of automation, as far more FX trades must be executed than with the current setup. For that reason, connectivity to a multi-dealer trading platform is a relevant part of the project.

In total, savings amounting to 1.2% of the total exposure (of several hundred € million) were generated, with the bulk coming from forward points optimisation (61.3%), reduced variability in performance (26.8%), and FX trading connectivity (11.0%).

(*) Every two weeks, Currency Pulse presents a real-life case. No names are mentioned, and absolute values are changed. We use simulation tools to backtest, with historical data, our proposed hedging programs.

Know your business

Kantox’s co-founder and Chief Growth Officer Antonio Rami takes the stage to discuss currency management and business strategy in the Kantox and treasuryXL webinar Your Currency Management Toolkit for 2024. 

Rather than focusing on the nuts and bolts of FX hedging programs, Toni emphasises the strategic relevance of currency management from a value-enhancing, growth-oriented perspective. Here are some of the main points:

• The champion. Most companies feature a ‘champion’ who understands the strategic importance of currency management. It can be the treasurer, the CFO, the CEO or an IT leader within the firm. This is the person who really cares about enhancing the value of the firm by using more currencies in business operations.
• Credit risk. A good manager understands the relevance of selling in more currencies in terms of reducing credit risk. In the event of a devaluation —particularly in Emerging Markets— customers can feel inclined to wait for a better FX rate before settling their bills if they are obliged to pay in a foreign currency. You don’t want to be in that position. 

“The old adage ‘Know thyself’ is important, but here’s an equally important one: Know your business. Different parts of the company may have different pricing parameters and different types of exposure to FX risk. The finance team needs to learn the business from the ground up. This is the key message for 2024” — Toni Rami

• Pricing with forward rates. Treasurers should provide commercial teams with all the FX rates they require, especially the forward rate when the firm sells in a currency that trades at a forward discount. This is not only about protecting profit margins. It’s also good commercial practice because it removes the need for competitiveness-busting markups. 
• FX centralisation. The advantages of centralising FX risk management are overwhelming. However, centralisation should not be implemented in an arbitrary manner. On the contrary: the first step is to thoroughly understand the business characteristics of each subsidiary—and only then deploy a centralised approach for FX policy and external trade execution.

Currency mismatch: the other FX risk

A relatively little-talked-about FX risk comes from unhedged emerging markets companies that fund assets with USD-denominated debt. This relates to the ‘financing principle’ in corporate finance: while long-term projects should be funded with long-term debt, assets with cash flows in dollars (euros) should be funded with dollar (euro) debt [see]. 

“The intuition behind matching does not require elaborate mathematical reasoning. It is built on common sense. When you mismatch debt with assets, you increase your likelihood of default, and holding debt ratios constant, your cost of debt and capital” — Aswath Damodaran

A report by Moody's analyses the link between currency mismatches and the robustness of EM banking systems: “High dollarisation causes multiple problems when the local currency drops sharply in value”. This happens because local banks become vulnerable as their own liquidity and capital come under pressure.

As USD strength persists, these points are worth pondering. The currency mismatch problem provides yet another argument in favour of selling directly in local currencies, while 'taking ownership' of the underlying FX risk management process.

Five Useful Links

1. CurrencyCast with Bonnie Tomei. “There are no fundamental differences between U.S. and European CFOs when it comes to the outlook for 2024”, argues Bonnie Tomei as she discusses the role of the CFO with Kantox’s Agustin Mackinlay. Watch the full episode here.
2. The real effects of financial reporting. A recent paper analyses the positive implications of a strong system of control. At Kantox we defend the notion that automation —largely on the back of perfect end-to-end traceability— strengthens treasurers' capacity for control [see].
3. Fast payments: perception gap. The AFP's Digital Payments Survey Report displays a clear perception gap between treasurers in North America and other countries regarding digital payments, fast payments, the ISO 20022 standard—and even exchange rate risk [see].
4. Deepfake CFO. A Hong Kong finance worker at a multinational firm was tricked into paying out $25 million to fraudsters who were using deepfake technology with AI. The fraudsters posed as the company’s chief financial officer in a video conference call [see]. 
5. Czechia and the euro. A Bloomberg article sheds light on the love-hate relationship of Czech politicians with the euro. Euro adoption would mean yet another success for the common currency. It’s not a done deal, however. Although ⅔ of exports go to the eurozone, only 27% of Czech citizens support adopting the euro. 

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