Spend Matters welcomes this guest post from Jeff Amsel, vice president of business development, and Shruti Jain, senior analyst, of the Smart Cube.
High volatility in the $5.3 trillion-a-day foreign exchange (FX) market is dragging down corporate earnings globally. Factors such as quantitative easing by the European Central Bank, U.S. Federal Reserve’s tightening policies and currency devaluation in China are expected to have lasting effects on global markets.
In 2016, the prime currency picks are likely to be the euro, Russian ruble, Japanese yen, Chinese yuan, Brazilian real and Argentine peso. Any strong movements in these currencies are likely to have significant financial consequences for companies.
According to an industry report, in Q3 2015, over 40% of the North American corporations surveyed reported losses due to currency movements. Respondents attributed a whopping loss of $24 billion ($19 billion in North America and $5 billion in Europe) — a 200% year-on-year drop and a 23% quarter-on-quarter rise — to FX volatility, translating to an average impact of $169 million and $473 million (on respondents that quantified this impact) in North America and Europe, respectively. The electronic instruments and controls and chemical manufacturing industries were highly impacted in both the regions. Majority respondents’ FX exposure was driven primarily by currency culprits such as the euro, the Japanese yen and the Brazilian real, with yuan volatility playing a significant role.
What Should Procurement Executives Do?
The procurement function, by nature, is heavily impacted by FX volatility, especially in the case of companies that operate complex international supply chains. Even for companies that enter into contracts solely in their local currency, foreign suppliers typically factor in currency risk in contracts. Further, due to lack of FX volatility management, companies may miss cost-saving opportunities when exchange rates move in their favor.
Thus, it has become vital for corporations to adopt robust FX management techniques to navigate such scenarios. The Smart Cube suggests the following strategies to mitigate exposure to currency risk, explore potential opportunities arising due to FX volatility and strengthen the agility of their supply chains:
- Agree on baseline exchange rates in contracts with suppliers.
- Understand suppliers’ exposure to foreign currency. FX risk exposure knowledge allows procurement executives to renegotiate prices during strong FX fluctuations and to enter into financial hedges, as appropriate.
- Measure FX currency risk across the entire supply chain. Allows for greater visibility into the cost factors and enhances supply chain agility.
- Use risk management tools/models and data analytics. Leverage mathematical risk management tools, predictive models and data analytics to determine exposure to FX volatility and assist future decision-making with timely visibility into which currencies impact the company the most and why.
- Maintain multiple suppliers — both local and foreign. Switch suppliers depending on which represents the best value as per prevailing FX movements.
- Assess transacting in currencies that are pegged to the company’s domestic currency or whose fluctuations correlate closely with that of the domestic currency.
- Evaluate adopting natural hedging by balancing selling and purchasing in the same currency.
- Assess using in-house banks to improve visibility and control over FX risk, by enabling better use of internal balances to create a natural hedge.
- Consider adopting commodity hedging techniques by taking a short or long position in futures contracts. This strategy does carry additional risks in cases wherein commodity prices drop or currencies move in a favorable direction, and hence, a thorough analysis of the industry is required before making the hedge.
These strategies are aimed at enabling procurement executives to fine-tune their supply chains to become more resilient. Executives can work closely with their internal treasury teams or third party organizations to evaluate which strategies to implement and how. What remains to be seen is whether they will be able to successfully integrate these strategies into their long-term vision and navigate the turbulences in the FX market to stay ahead of the game.
If you are an industry professional, the following questions could be worth exploring:
- Have you measured the impact of currency volatility on your current and future earnings?
- Which business function (sales, procurement, etc.) is most heavily impacted by FX volatility?
- Which of the above strategies are suitable for your company to mitigate currency risk?
- What are the key best practices regarding FX risk management followed in your industry?