Avoiding Risky Business: FX Hedging Best Practices · Avoiding Risky Business: FX Hedging Best...
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Avoiding Risky Business: FX Hedging Best Practices Ed Sauve & Joe O’Leary May 26, 2011
Transcript of Avoiding Risky Business: FX Hedging Best Practices · Avoiding Risky Business: FX Hedging Best...
Avoiding Risky Business:
FX Hedging Best Practices
Ed Sauve & Joe O’Leary
May 26, 2011
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Today’s Speakers
• Ed Sauve, Senior Foreign Exchange Advisor, Silicon
Valley Bank
• Joe O’Leary, Senior Foreign Exchange Trader,
Silicon Valley Bank
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Topics for Today
• Globalization, Foreign Exchange and Your Company
• Perceptions and Reality
• Best Practices
• Common Hedging Instruments
• Regulatory Update
• Q&A
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Globalization, Foreign Exchange
and Your CompanyEd Sauve Senior Foreign Exchange Advisor,
Silicon Valley Bank
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Global Expansion
Foreign exchange-Foreign currency impact unavoidable
• Impact even if all business is conducted in USD
• Rate of exchange between two currencies is not fixed
• Volatility of exchange rates: $1.4827 = EUR 1.0000 as of 5/4/11
$1.4316 = EUR 1.0000 as of 5/6/11
3.5% value change in 2 day
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Foreign Exchange Market
• Massive: Dwarfs all exchanges
• Global
• 24x7
• Unregulated freely floating currencies
• Volatility
• Not uniform (e.g. restricted)
• Wholesale market and market makers vs. small bus./retail
• Bid-ask quotes based on spot market (e.g. bid $1.4750) Ask $1.4755 to purchase 1
euro (EUR). Two day settlement
• Duality-currency pairs (EUR/USD; USD/JPY)
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Foreign Exchange and the Enterprise
Treasury operations
o Pay overseas vendors and/or employees
o Invest capital and fund foreign operations
o Channel sales proceeds (A/R) denominated in foreign
currencies
o Receive dividends, funded debt and return capital
denominated in foreign currency
• Strategic transactions
• Reliable and timely execution is critical
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Foreign Exchange Risk
• Foreign exchange rates fluctuate continuously: volatility
• FX gains or losses unless every current and future FX exposure is
perfectly offset in terms of amount and settlement date
• Key factors: Amount, direction & maturity/settlement
• Types of risk:
o Transaction Risk: Exposure based on identified funds flow such as foreign
currency receipts or payments
o Translation Risk: Exposure from foreign currency denominated assets, liabilities,
and capital
o Economic: Long term impact of exchange volatility (e.g. pricing in USD versus
competition in local currency)
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One time large
order from regional
hospital group in
Europe
Upon receipt of firm purchase order the Med Device company is “long” EUR
for 90 days and is “exposed” to the risk of fluctuations reducing USD
proceeds on the day the buyer pays the EUR 1.5MM.
Medical Device
systems company
selling to U.S.
customer base
•EUR 1.5MM
•Sold on 60 day terms
• P.O. received 30 days before shipment
Foreign Currency Cash Flow #1 and
Related Foreign Currency Exposure
•EUR 1.5MM
•Sales proceeds due 60 days after invoice
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Pre-Clinical trials in
France
At current rates company can be said to be:
•“Short” EUR 125,000 per month = to $180K or $2.16MM for the year at $1.44 =
EUR 1.00
•Also “short” GBP 35K/month = to $57,050 or $684,600 for the year
Research expense
in UK
Clinical trials in
Germany
Early stage Life
Science company
pre-revenue
well funded and
product(s) in
development
EUR 100K/ Month
EUR 25K/ Month
GBP 35K/Month
Foreign Currency Cash Flows #2
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Large Japanese
corporate customer
At current rates company is:
•“long” EUR 125K/Month = to $180K or $2.16MM for the year at $1.44 = EUR
1.00
•Also “long” JPY 75MM/Month = to $937,500/Month or $11,250,000
•Also “long” GBP 50K/Month = to $81,500 or $978,000 for the year
UK sales subsidiary
European
distributor
(on continent)
Growing electronics
company
U.S. dollar expense
base
but overseas
demand and need
to sell in local
currencies
EUR 125K/ Month
JPY 75MM/ Month
GBP 50K/Month
Foreign Currency Cash Flows #3
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Canadian
customers
•Net Long EUR 1.875MM/Month
•Also Net “long” GBP 400K/Month
•But Net short JPY 45MM/Month
even with JPY revenue
•Long CAD 100K/Month
•Latin America sales in USD
UK sales branch
sales = GBP
450K/Month
Dutch based
European HQ and
sales subsidiary
Major software
company with
extensive overseas
sales
EUR Sales = 2MM/Month
CAD= 100K/Month
GBP Exp=
50K/Month
Foreign Currency Cash Flows #4 (and it
can get even more complicated)
Customers in
Germany
Customers in
France
Customers in
Italy
Customers in
Spain
Customers in
Sweden
Customers in
Eastern
Europe
Japan branch
sales= JPY
80MM/Month
Sales to customers
in Latin America
EUR
Exp
Exp =EUR
125K/Month
GBP
Exp
JPY
Exp
JPY Exp=
125MM/Month
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Hedging StrategiesJoe O’LearySenior Foreign Exchange Trader,
Silicon Valley Bank
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Definition of Foreign Exchange Hedging
• “We use financial instruments to mitigate exposure”
• “Entails giving up some opportunity / gains to reduce risk”
• “Protects my revenue”
• “Foreign exchange hedging is a financial strategy used to protect
my business against volatility in world currency markets”
• Important to have “cash flow predictability”
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Market Forecasts vs. Reality
Source: Reuters
■ Predicted ■ Actual
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Risk Curve Analysis – Standard Deviation
1.2
1.25
1.3
1.35
1.4
1.45
1.5
1.55
EUR/USD
1.2
1.25
1.3
1.35
1.4
1.45
1.5
1.55EUR/USD
Probability
Source: Bloomberg
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Common Misconceptions
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Misconception: Hedging is a Form of Speculation
Reality
• Not hedging is actually a form of speculation
• Hedging is another risk management strategy
• Look at competition
• Over-hedging could be speculating
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Misconception: Foreign Exchange Movements
Even Out Over Time
Reality
• What is your time horizon?
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Source: Bloomberg
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Misconception: A Company is Immune to
Foreign Currency Dynamics
Reality
• Pricing and reporting in USD does not mitigate currency risk
• Company size does not matter
• Both private and public companies can benefit from FX hedging
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Misconception: Too Time Consuming
• Average time spent on the programs was 3 hours a month
• 4 hours at quarter end
• Most time consuming process was gathering cash forecasts
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Getting Started
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When to Consider FX Hedging
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• Selling overseas
• Buying from overseas suppliers
• Setting up manufacturing facilities overseas
• Outsourcing R&D or customer support
• Overseas acquisitions
• Balance sheet revaluations
• Competing with overseas competitors
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Getting Started
ANALYSIS DEVELOP FX POLICY CHOOSE STRATEGY
AND EXECUTE
MONITOR EVENTS
AND RESULTS
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Analysis
Data collection to identify global exposure
• Forecasted sales, purchases, profits, dividends
• Firm commitments: sales or purchases not yet booked
• Transactions booked: A/R, A/P
• Inter-company transactions / transfers
• Short and long term investments
Exposure analysis
• Quantify exposure to determine financial impact
• Compare quantified risk with cost of hedging
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Strategic Approach to Risk
Fully Hedged
Partially Hedged
No Hedge: Actively Tracked
No Hedge: Reviewed Regularly
LOW HIGH
HIGH
$ IMPACT
PR
OB
AB
ILIT
Y
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Develop a Foreign Exchange Policy
FX Policy
• A framework approved by the board
that incorporates all aspects of FX risk
management
o Reflect corporate goals and objectives
o Buy-in from management
o Ensure commitment of resources
o Consistency in FX activities
o Accounting issues
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Develop a Foreign Exchange Policy – cont.
Policy Components
• Objectives
• Risk tolerance-Passive? Active?
• Hedging strategies
• Accountability/oversight
• 100% of corporations that hedge have an FX policy
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Choosing the Right Strategy and Executing
Common Hedging Instruments
• Natural offset: Currency accounts
• Forward contracts
• Over-the-counter options
• Structured option strategies
Work with your accounting and senior management to ensure your
selected instruments are appropriate for your company. Are they in
your FX policy?
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Monitor Events and Results
• Ensure exposures are being hedged as planned
• Develop regular reports to evaluate success of hedges in meeting goals
o Mark-to-market report
o Exposure report
• Be alert to events or FX rate changes that may affect your business
• Identify/learn new hedging tools
Common Hedging Practices
Association of Corporate Treasurers
• 90% centralized hedge management
• 80% hedge cash forecasts (AP, payroll, AR, cash balances)
• 80% Net FX assets and liabilities
• 80% hedge to minimize risk (transactions and earnings)
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Common Hedging Strategies
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Natural Offset
• Easier and less time consuming
• Utilizing non- USD accounts to collect and pay in same currency
• Allows for cross currency trades to help mitigate risk. Higher
correlation (AUD,GBP, EUR, CAD)
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“No Free Lunch”
Forwards Options
Flexibility/Upfront costs
Least Most
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Forwards/Window Forward
• Contractual agreement that your foreign currency payment or collection,
scheduled to take place on a particular date in the future, will be
converted at a fixed date and fixed exchange rate regardless of market
fluctuations.
• No upfront costs
• Protect against currency depreciation/appreciation
• However, NO benefit, should the currency move in your favor
• Window forward - adds more flexibility only the timing. The value date is
not a fixed date but a window of time. Great for A/R.
Forward Contract- Example
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• SVB buys your 1.5 Mio. EUR at 1.4255(1.4285-.0030), Value 8/31/11
• Window: SVB buys 1.5M EUR at 1.4250(1.4285-.0035), Value 8/15/11
to 9/15/11
One time large
order from regional
hospital group in
Europe
Medical Device
systems company
selling to U.S.
customer base
•EUR 1,500,000
• Sold on 60 day terms
• P.O. received 30 days before shipment
•EUR 1,500,000
•Sales proceeds due 60 days after invoice
Upon receipt of firm purchase order the Med Device company is “long” EUR for 90 days and
is “exposed” to the risk of fluctuations reducing USD proceeds on the day the buyer pays the
EUR 1.5 million
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Plain Option
• An option gives the buyer the right, but not the obligation
to fulfill the option at maturity
• The premium is the cost paid by the buyer of the option
• The strike price is the rate at which the option is valued
• An “insurance policy”
• Regulatory concerns
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Option Example
• Buy a EUR put, strike at 1.4255, maturity 8/31/11
• Premium is 2.5%
•At maturity, if EUR >1.4255 = don’t execute option
•At maturity, if EUR < 1.4255= execute and sell at 1.4255
One time large
order from regional
hospital group in
Europe
Medical Device
systems company
selling to U.S.
customer base
•EUR 1,500,000
•Sold on 60 day terms
•P.O. received 30 days before shipment
•EUR 1,500,000
•Sales proceeds due 60 days after invoice
Upon receipt of firm purchase order the Med Device company is “long” EUR for 90 days and
is “exposed” to the risk of fluctuations reducing USD proceeds on the day the buyer pays the
EUR 1.5 million
Financial Reform Update – Issued May 2012
• Treasury notice of “Proposed Determination on Foreign Exchange Forwards
and “Swaps”
• Background: Dodd Frank Act Financial Reform federal initiatives to further
control use of financial derivatives
• Widespread effort to exclude foreign exchange instruments
• Treasury Notice exempted FX forwards and swaps from the new restrictions
and limits on financial derivatives to be applied to interest rate and other
derivative financial instruments
• However FX options and hybrids and non-deliverable forward contracts
were not protected from the new provisions which could include:
o Cash margins
o Move trading to an exchange
o Increased financial reporting
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Questions?
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Contacts
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Ed Sauve
Ed Sauve
Senior Foreign Exchange Advisor
949.754.0816
Ed Sauve is the senior advisor for the Global Financial Services Group
of Silicon Valley Bank and he has 20 plus years of commercial banking
experience including provision of credit and delivery of a wide variety of
financial services to small business, middle market, institutional and
multi-national companies.
Sauve's international banking experience includes assignments in
London, Middle East and Hong Kong. He opened Middle East Area
Representative office for First Interstate Bank in the United Arab
Emirates and led a program to obtain license to open its bank office in
Beijing, China. Currently he supports the international activities of SVB's
Southern California-based clients.
His domestic experience includes management of regional corporate
centers in Los Angeles and the South Bay for Wells Fargo/First
Interstate, as well as regional responsibility for marketing Silicon Valley
Bank's short-term money market capabilities in Southern California. He
has transaction experience in commercial lending, cash management,
corporate finance, short-term money market investments and
international banking.
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Joe O’Leary
Joe O’Leary
Senior Foreign Exchange Trader
408.654.1017
Joe O'Leary has over 14 years of experience working in the financial services
industry. As a seasoned foreign exchange professional his knowledge extends from
consultative marketing in foreign exchange principals, extensive knowledge of
currency risk management and experience in gathering, evaluating, and hedging
foreign exchange exposures for multinational corporations. His duties have included
offshore interest rate products, asset liability management, foreign exchange trading
and corporate foreign exchange risk management.
O'Leary joined SVB in May of 2006 as a foreign exchange advisor. Currently in his
capacity as senior foreign exchange trader, he prepares custom hedging strategies
for clients with complex currency-related issues, advises clients in developing,
implementing, and monitoring foreign exchange strategies and educates clients in
understanding foreign exchange products. In addition, O'Leary manages SVB's non-
USD loan portfolio and mitigates the banks FX exposure.
Prior to joining SVB, O'Leary was a treasury manager at a large hard disk drive
manufacturer based in, California, where he managed the corporation's foreign
exchange exposure. Additionally, O'Leary worked with overseas offices on cash
forecasting, standby letters of credit and general ledger accounts. O'Leary began his
career at the Bank of Hawaii (BOH) where he held various positions within the
bank's treasury department.
O'Leary holds a bachelor's degree in International Business from the University of
Hawaii, Honolulu. He also holds a certificate on foreign exchange principles from the
World Trade Institute in New York, New York, and O'Leary is a member of the
Association for Financial Professionals.
Advisors
West
Dave Bhagat
Senior FX Advisor
650.320.1158
Dennis Brown
Senior Trade Finance Advisor
949.754.0838
Ed Sauve
Senior FX Advisor
949.754.0816
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CentralMatt Wysong
Trade Finance Advisor
303.378.7024
Laurence Hayward
Senior FX Advisor
972.455.0961
East
Carla Winfield
Senior Trade Finance Advisor
617.630.4154
Drew Devine
FX Advisor
617.630.4145
Paul Jennings
Senior FX Advisor
617.796.6934
Scott Petruska
Senior FX Advisor
617.796.6930
WestMary Jo Mack
Senior FX Advisor
415.806.5341
Todd Brothers
Senior FX Advisor
415.764.3153
4646
Disclosures
Foreign exchange transactions can be highly risky, and losses may occur in short periods
of time if there is an adverse movement of exchange rates. Exchange rates can be highly
volatile and are impacted by numerous economic, political and social factors, as well as
supply and demand and governmental intervention, control and adjustments. Investments
in financial instruments carry significant risk, including the possible loss of the principal
amount invested. Before entering any foreign exchange transaction, you should obtain
advice from your own tax, financial, legal and other advisors, and only make investment
decisions on the basis of your own objectives, experience and resources. Opinions
expressed are our opinions as of the date of this content only. The material is based upon
information which we consider reliable, but we do not represent that it is accurate or
complete, and it should not be relied upon as such.
