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Hedge Schedule Development: Aligning exposures, FP&A and best practices

CalendarFebruary 13, 2024
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Hedge Schedule Development:

Aligning exposures, FP&A and best practices

Every business is unique in its structure, operations, and financial goals. Thus aligning foreign exchange hedging to a given business’s unique budgeting and decision-making processes can potentially offer greater control and better results.

For many businesses, static hedging—the ‘set it and forget it’ approach—is their default. While setting a hedging plan for a full year or accounting period has benefits in certain circumstances, it can also lead to a delayed impact of FX movement on the balance sheet, and it can affect planning and pricing strategies for the next accounting period.

Thus aligning hedging programs to business cycles can help to benefit your business and your bottom line.


Introduction

Businesses vary widely across industries and even within them. Essentially, every business is unique in the details of its structure, operations, and financing. These nuances shape budgeting and decision-making frameworks; likewise, optimal FX hedging tends to properly factor in those nuances.

Similar to constructing an investment portfolio, a hedging schedule’s structure is often the largest driver of its performance. Many of Corpay’s hedging customers find it critical to match the construction of the hedge schedule’s structure with how their specific business budgets and operates.

There are three main hedge frameworks used by corporate hedgers in Corpay’s customer base. In this essay and the following, we will outline them, and highlight some pros and cons of each one under different market outcomes.

We’ll begin with the Static Hedge.

The static hedge: ‘Set it & forget it’

Often the first thought when businesses are considering an FX hedging program is the static hedge framework. This is a fairly common 'set it and forget it' approach. A percentage of the underlying FX exposure is typically defined at the beginning of the year (or other hedging period), and tied to rates and milestones outlined in the budget. For an annual hedging program, then, one hedge is executed for the full year.

Here is an example of a static hedge; 50% of the currency exposure is hedged each month:

This approach shields budgets from immediate FX impact, but it may have drawbacks over the longer term.Foremost amongst them is the fact that this framework tends to delay FX risk by pushing it into a different year or reporting period – as opposed to more substantively reducing such risk.

For example, if the FX market were to move 15-20% from the time the hedge is set to when it expires, the business may be facing dramatically different FX rates when planning for the next year. This ultimately can have downstream impacts on the business’ pricing, budget, and planning for the next period, impacts that may be difficult to address.

Here is a hypothetical outcome for a static hedge:

When it works, it works: Project-based exposures

That said, static hedge schedules can be ideal for FX exposures and budgets that are project-based and time-delimited, as is common in the construction and entertainment industries. A static hedge may also be a good choice for businesses which, for financial reporting purposes, do not want to carry hedges from one accounting period into the next. This may be viable for a business with shorter or more dynamic pricing cycles, as they may be able to pass off any impact from FX movements to customers or vendors without impacting their competitive position.

While opting for delayed impact from any rate movements can work for some firms or in specific circumstances, it is not a one-size-fits-all approach. There are risks to a ‘set it and forget it’ strategy when deferred FX moves are realized when a business enters a new financial reporting period which may have a radically different rate environment. This can then impact pricing and profitability.

In conclusion: Static hedges

Aligning how a business operates and plans with its underlying FX exposure and time horizons tends to be an important component of effective FX risk management. A static hedge program may be the first option considered when hedging because of its simplicity. Outside a narrow set of circumstance types, however, this approach tends to involve major downsides that can even outweigh the advantages for many businesses. It is therefore important to assess those advantages and disadvantages against your business, so you are confident you are making the best decision.

Market-leading hedging insights can drive significant value in addressing implications of FX volatility in a manner aligned with a business’ financial planning and pricing cycles.

How do your financial planning and hedging align?

Corpay can be a resource for you as you evaluate your exposures and plan your hedging program. We can offer our expertise and our toolkit to help you model risk and help you align your planning to your unique business goals.

Opinions expressed in this article are those of the author. Please consider contacting an independent advisor of your choosing – an advisor completely independent of Corpay – to help you ensure that solutions discussed here are right for your business’ needs.

The hedging products described in this document can be useful but are also associated with significant added complexity; obtaining a thorough understanding of each such product's trade-offs/pros-and-cons (fully describing these is beyond the scope of this article) is important before choosing to use any of these products.

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Author

Sean Coakley, CFA

Sean Coakley, CFA

Director, Strategic Sales, & Market Strategist

Sean works with mid-market corporates, focusing on FX risk management and international working capital optimization. He blends experience in finance and capital markets with a robust understanding of business performance and capital markets knowledge.

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