Protecting Against Corporate Volatility Risk

Volatility in global markets, and in particular, the debt crisis in the eurozone has placed many corporations at greater risk, and in particular FX risk. “Vulnerability to Volatility Risk – a Global Challenge,” a survey conducted by the Economist Intelligence Unit, concluded that a majority of bankers, insurers and asset managers, as well as finance executives at non-financial companies, consider their organizations to be vulnerable to exceptional or sudden swings in volatility. More than half of the respondents in this survey say their company conducts stress tests or scenario analysis to check their ability to cope with volatility just once a year or once in six months. That means the majority of these organisations are seriously exposed in today’s fast-moving markets.

With the debt crisis likely to persist, European companies as well as multi-national corporations doing business in the region must protect themselves against unfolding events. This will require them to be aware of their exposure against the Euro as well as their exposure within each country.

The first step a corporate treasurer will want to take is to leverage treasury technology to create accurate cash forecasts over an appropriate time window, say 12-24 months, for each Entity engaged in commerce within Europe. You will want to ensure that this can be broken down to a minimum of Entity and Country level and preferably the receivables/payables types. These forecasts are typically derived using a number of different methods. The first is to extract ERP data for payables, receivables, payroll, etc., and use this to forecast, but this method typically has a very short time horizon due to the amount of future data held within an ERP. Another method is to use historical data and apply predictive forecasting tools to project this data into the future with assumed growth patterns, seasonal trending, etc. Lastly, each Entity could provide its own cash forecast via a web interface which can be consolidated into a central forecast at the treasury center. All of these methods have their advantages and shortcomings so it is important to periodically check forecasts against actual to ensure the validity of the methods used.

Once your business has an accurate cash forecast there are a number of ways the data can be analyzed using treasury technology. First, your existing currency trades can be consolidated with the forecasts to create an aggregated position to show your overall exposure. This can then be run through a variety of scenario models where interest and currency curves can be shifted up and down to analyze portfolio risk. Doing this allows you to see where you are most sensitive to changes in underlying rates and where your biggest exposures are. In addition, more advanced methods like Value at Risk (VaR) can be employed which help to illustrate the biggest exposure risks, in the case of a major event. To further analyze your risks, and how different hedging strategies could mitigate them, groups of synthetic trades can be created based on different hedging programs. These synthetic trades can then be layered into both the scenario models and VaR calculations to illustrate the effects of these strategies. This type of modeling can also be applied to the credit ratings associated with each Country so that the potential effect of a credit downgrade on a country or an individual counterparty can be measured.

Whether large or small, many global corporations are deeply aware that fluctuations in the FX market present a set of risks that must be closely monitored and strictly managed. In an effort to minimize those risks, corporations can leverage treasury technology to not only assess their exposure, but to also analyze FX scenarios that affect cash and liquidity.

Are you leveraging treasury technology to protect against volatility risk?