In a market crisis, investors rush to safe haven assets, which for the currency market tend to be the U.S. dollar, the Japanese yen and the Swiss franc, strengthening those currencies. At the same time, money moves out of emerging markets, which depreciates those currencies.
In this troubled market, a depleting demand for oil has caused crude prices to collapse. That has also had a negative effect on emerging market currencies that are highly tied to oil. These actions together have created significant risks for many U.S. businesses.
“Another unfortunate aspect of a crisis like this is that business forecasts just get totally thrown out the window,” says Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank. “When companies hedge, they often project out a year or two. But in a crisis like this, those forecasts are cloudy at best. It’s a paradox that in a crisis hedging is more important — you want to be protected and insulated against risk — but it’s difficult to implement because of the uncertainty in exposures. It’s a tough environment to deal with.”
Smart Business spoke with Altman about risk-hedging strategies for companies that have exposure to international currency markets.
Who has exposure to risk in foreign currencies at the moment?
If you are selling in foreign markets and the dollar strengthens, then the value of those foreign sales goes down, which can have a significantly negative impact for larger companies. If you’re manufacturing or purchasing material outside the U.S., the strong dollar could be beneficial because it gives you more purchasing power there.
There is also a second-level effect. If you’re a U.S. company primarily dealing in the U.S., you might not have direct foreign currency exposure but you might work with suppliers or customers that are foreign-owned or have operations that are heavily involved in international supply- chain activities. They might become impacted by foreign exchange rates or market impairments. And even beyond foreign exchange rates, international supply chains are facing challenges because companies have had to furlough employees or are partially or entirely shut down.
How can companies mitigate their exposure to risks in foreign currencies?
If you’re concerned about international risk, consider extending hedge tenors. A typical hedge might be inside six months or a year. But now you might want to consider looking out two years because you’re concerned about the longer-term risks to the business.
The other thing that you can do is increase hedge ratios. You may typically look to hedge 50 percent of your foreign purchases out a year, but now you might want to hike that up to 75 percent or all of what you anticipate purchasing because of the risk in the market.
When you’re very certain about hedging, you can enter into a forward rate contract and that’s what a lot of our companies use to enter foreign exchange hedges. But if you don’t have total certainty in the underlying exposure, then you should look for alternative hedge instruments, such as FX Options. That’s something to talk with your banker about to find the best strategy.
Should companies now focus on risk mitigation or finding opportunities?
Initially it’s important to stop the bleeding, focus on shoring up core capabilities and be really diligent about your risk management framework. Identify and quantify critical risks in the context of your risk tolerance, then look for strategies to hedge the risks that exceed that tolerance. This process can be done with a banker or accountant, who can then help you come up with a plan to hedge risk. With the bleeding stopped, you can be on the lookout for opportunities with partnerships, investments and in the M&A space, for instance.
There is uncertainty right now that makes hedging strategies difficult. Working with a bank and developing a plan within your strategic framework can help you identify risks and develop a plan of attack.
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