U.S. Dollar strengthening is often a good-news-bad-news story for multinational companies. For U.S. companies with overseas cost centers, the weaker foreign currencies are a boon to the expense-related line items. Conversely, for U.S. companies that depend on foreign revenue, the relative weakness of foreign currencies translates to less USD, leading to painful revenue compression. These fluctuations in global currency rates can be even more impactful when it comes to highly sensitive currency events, such as foreign acquisitions or divestitures. Known risk events, including looming Brexit and China trade tensions, only exacerbate the possibility of unforeseen currency events. In any case, a disciplined and nuanced approach to hedging foreign currency risk is more important than ever in this evolving market landscape.
With the backdrop of looming Brexit uncertainty, GDP growth slowdowns in major European economies, and slower exports from most Asian economies, the U.S. Dollar has strengthened broadly across most global currencies. Against EUR-USD and GBP-USD, the greenback has strengthened 5.3% and 6.1%, respectively, with GBP-USD in particular hitting its lowest point in 2.5 years, dipping below the 1.20 mark on September 3. Moreover, EUR-USD dipped below 1.10 on Aug 30 for the first time since 2017. In Asia, the U.S. Dollar has strengthened in particular against AUD and CNY, with USD-CNY eclipsing the 7.0 mark in August following back-and-forth tariff threats from the two countries. More broadly, to the extent that the global economic slowdown continues, investment flow could continue to shift into safe haven USD assets which would lead to even further dollar strengthening.
Operational FX hedging programs
For companies with regular cash flows in foreign currency, an operational hedging program is a best practice to mitigate both margin compression on forecasted cash flows and remeasurement risk for monetary assets and liabilities on the balance sheet. A disciplined program governed by a hedging policy will mitigate risk within identified risk tolerance thresholds for any company. In this context, it is important for a company to quantify its risk, identify its tolerance, and construct a program that efficiently limits currency risk to acceptable bands. Further, having the appropriate technology, accounting expertise, and internal communication rhythms are necessary elements to ensure the operational hedging program is effective and sustainable.
Event-driven hedging strategies
In other cases, companies will seek to mitigate risk to a particular event, such as an acquisition, divestiture, or sizable foreign interest payment. For known events, such as foreign bond payments or dividend payments, FX forwards provide an efficient hedge that drives certainty in the outcome. In other cases, such as foreign acquisitions or divestitures, there is risk of a deal not closing in which case hedging can create additional exposure. In those cases, deal-contingent hedging can be attractive for companies who wish to mitigate FX risk associated with a particular event but would like to avoid the dead deal cost if a hedge moves against them along with a deal not closing.
Whether it’s hedging to protect foreign revenues against the stronger dollar or hedging to de-risk the purchase price of an acquisition, Chatham Financial can partner with your treasury team to develop and execute a risk management strategy that aligns with your organization’s objectives. Our full range of services includes risk management strategy development, risk quantification, exposure management (interest rate, currency and commodity), outsourced execution, technology solutions, and hedge accounting. We work with treasury teams to develop, evaluate and enhance their risk management programs and to articulate the costs and benefits of strategic decisions.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit https://www.chathamfinancial.com/legal-notices/.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved. 19-0243
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