Drawing from her own experience, Uyen Vo – a GBRW Principal Consultant – examines four stumbling blocks that organisations can sometimes struggle with when developing a robust FX risk management infrastructure.
Incorrect booking of FX entries
A fundamental but often overlooked area is the base data itself. FX is sometimes misunderstood by staff and, therefore, foreign currency entries can be booked incorrectly. For example, one client’s accounting team booked foreign currency liabilities as home currency because they were hedged with cross-currency swaps. Clearly, this would have led to the wrong FX risk position. Therefore, it is important to test the raw data first to ensure that any material discrepancies are captured early on.
System, ledger, legal entity complexity
Organisations with multiple systems and/or sub-ledgers should take additional care because areas like internal netting becomes more opaque. Clients with branches and/or subsidiaries in foreign countries will face additional complexity as both the FX risk to the parent company and foreign operating entities must be considered (for example, with foreign subsidiaries, home currency could actually be classified as an FX risk). It is useful to map out the risk onto a ledger, system and legal entity ‘structure chart’ to more clearly identify true exposures.
FX sell-down processes
Many booking systems are set up to conduct an automatic sell-down of FX risk, and manual processes often exist too. If the business is large or loosely connected (as is often the case when a recent merger or acquisition has occurred, say), these processes may not yet be linked together. It is therefore important that time is taken to identify all pre-existing FX management processes first before taking any mitigating action. This may appear obvious but, over time, it is easy to forget automatic processes – especially with staff turnover.
Accounting
The purpose of market risk management is usually to reduce both economic and accounting volatility. Therefore, the proper accounting of the hedges should not be overlooked. Revaluation of the hedge and the underlying exposure are booked against different lines (for example, when hedging cash flows with a forward contract or a subsidiary with a net investment hedge) so Finance needs to be engaged to ensure that the correct hedge accounting treatment (IFRS 9) is adopted to avoid unnecessary and undesirable volatility.