How can treasury teams manage risk across foreign exchange (FX), interest rates and commodities in this context – and what lessons can be learned from recent years?

The key question on the minds of many corporates is what the impact of this most recent chapter of uncertainty will be on their underlying businesses, cash flows and key performance indicators (KPIs). From there, they want to understand how it may impact their risk tolerance and how they should adapt their hedging policies and decision-making as a result. 

Flexibility in FX hedging 

When it comes to managing FX risks, the COVID-19 Pandemic is fresh in the minds of many treasurers. Companies found themselves taking losses on hedges they no longer required as forecast business cash flows evaporated. 

This experience reinforced the need to build flexibility and agility into FX hedging policies to deal with changing forecasts, timing uncertainty, and rapidly moving markets. This approach is transferable considering today’s uncertainty. 

While we see companies continuing to take a systematic approach to transaction hedging, some are flexing policies to hedge towards the lower end of FX hedging ratios or are delaying placing ‘top-up’ hedges to avoid over-hedge scenarios. This effectively ‘buys time’ in the expectation that greater clarity over trade policy impacts will allow a more confident assessment of future needs. 

Another approach that can help capture favourable market movements is adapting hedge execution approaches to include the use of orders, under which FX hedges are executed only when a particular market rate is reached.

High interest rates with uncertain path ahead 

In relation to interest rate risk, increased uncertainty over the future path of rates and central banks’ policy responses has led to a degree of nervousness around decision making, with some companies waiting to implement hedges where they can – not necessarily for better rates, but to weather the storm and let some of the uncertainty pass. 

Companies continue to proactively review the fixed/ floating mix of their debt portfolios as they adapt to the higher rates environment. Many had been considering increasing the proportion of floating rate debt in their mix to take advantage of falling interest rates. However, the timing of this decision is now more nuanced given the uncertainty over the future path of interest rates. 

On the flipside, diverging central bank policies across major currencies present an opportunity for companies to rebalance their debt currency mix to take advantage of increased interest rate differentials and potentially reduce overall funding costs. 

On near-term funding requirements, pre-hedging is an important consideration and, in volatile markets, can provide a means of ‘averaging into’ a benchmark interest rate over a period of time, rather than being subject to a single pricing point. Again, this approach needs to be tailored to take account of any uncertainties in funding plans. 

Opportunities for commodity hedgers 

Commodity price risk has moved up the risk management agenda in recent years due to historically high prices and volatility. The recent economic uncertainty has, if anything, offered a degree of respite for clients – especially as crude oil prices have decreased to levels not seen since early 2021. 

Accordingly, alongside raising hedging ratios towards the upper end of existing policy remits, many UK-based corporate fuel consumers have also looked to maximise the tenor on existing credit lines to take advantage of attractive price levels. Confidence about underlying domestic business conditions offers an opportunity to benefit from the downturn in global prices. 

A wealth of expertise 

Typically, corporates seek the expertise and experience of larger banks to help navigate their financial risk requirements. Lloyds, for instance, can offer market insights to keep teams informed on prevailing conditions, opportunities and execution approaches. Helping clients review and enhance hedging policies builds an appropriate level of flexibility and agility. This can both protect against and take advantage of potential market movements. 

Organisations can benchmark their risk management approach using peer analysis, minimising the risk of unintentionally being a relative outlier. Bespoke quantitative analysis provided by banks can help their clients to understand and quantify the impact of market risks to which they are exposed, and how changes to their fixed/floating mix, currency mix of debt or transactional hedging approach may impact their key financial metrics.