FX Hedging - the “seat belt” paradox
The vast majority of multinational corporations proactively manage their currency risks. Between balance sheet hedging, cashflow hedging, and other strategies - well-accepted frameworks and straightforward processes help businesses achieve specific objectives.
Yet most SMEs and a half of mid-market corporations that trade internationally shy away from proactively managing currency risks. According to the British Business Bank, 96% of UK SME exporters do not manage currency risks despite having international revenues.
It is not because multinational corporations are more exposed to FX fluctuations than smaller businesses. Given their size and diversification, the finances of a typical multinational corporation can withstand larger currency swings than their smaller competitors.
The issue of FX risks can pose a significant challenge for businesses operating globally, regardless of their scale. HedgeFlows has helped numerous businesses manage their international finances and FX risks. Throughout the journey, we encountered numerous teams who suffered losses amounting to tens, sometimes hundreds of thousands, due to currency fluctuations, all because they disregarded the risks associated with currency. All of them could put processes in place and leverage solutions such as HedgeFlows to avoid unexpected currency losses going forward. An intriguing phenomenon I've noticed during the process is what I call the "seat belt paradox".
The Seat Belt Paradox
The modern three-point seat belt was invented in 1959 by Volvo engineer Nils Bohlin. Seat belts are estimated to halve the risk of death or critical injuries, but most people were indifferent to their safety benefits first.
Being a “useless nuisance” 99.99% of the time, the value of a seat belt was hard to demonstrate. Not surprisingly, one 1984 survey found that 65% of Americans were against mandatory seat belts. It took government regulation that made seat belts compulsory in the 1980s to shift the status quo. Fast-forward to the modern day and 97% of UK drivers wear seat belts. Try driving your car without the seatbelt - your car will continue to annoy you with seat belt alert sounds, and your passengers will look incredulously at you. From being a “useless nuisance”, wearing your seat belt has become a norm.
If you work in a treasury function of a large multinational, FX hedging is viewed similarly to the seat belt. It demands resources and skills, but critical stakeholders commonly understand and accept the benefits. Try ignoring your FX risks - the internal risk management team or external auditors will make noises that are much harder to ignore than the seat belt alarm in your car. Manage your risks poorly, and external investors punish you by deeming your shares risky. FX hedging has become the norm.
The fallacy of seat belt that makes you go faster.
Unfortunately, FX hedging is as popular with many smaller businesses as the seat belt in the 1960s. Without proper education, guidance, and frameworks, many businesses perceive it as useless until they learn about its benefits from first-hand experience of losing money on their international trade due to currency moves. Many also mistake FX trading in order to get a better rate for hedging. This is akin to trying to figure out how to use the seat belt to drive faster!
Yet, the virtues of hedging currency risks are more easily understood when its objectives are aligned with specific financial or accounting metrics. Minimising the effect of currency swings on financial statements is the natural starting point. But FX rates are unpredictable, so how do you convince someone if they don’t know the benefits of hedging upfront?
FX Hedging on the Cloud
With cloud-based accounting and ERP systems making financial data easily accessible, solutions like HedgeFlows can help even small businesses quantify and understand their potential FX risks in minutes.
With automated risk monitoring, real-time transparent pricing for hedging transactions, and automated reconciliations, FX risk management can be easily automated and embedded into existing financial processes. From micro-hedging individual foreign invoices to more complex rule-based hedging frameworks - adding a risk management process can protect growing businesses from the volatile effects of foreign currencies without hidden costs or surprises.