• FX Hedging

Layered FX Hedging

Layered Corporate FX Hedging Strategy

Layered FX Hedging

Often when managing Corporate FX Risk, a layered approach to hedging is most suitable for goals and objectives.

Considering factors such as, market volatility and cash flow forecast accuracy, it is often suitable to hedge and maintain percentage levels over periods of time, which are added to in layers at regular intervals.

As opposed to committing a significant portion of FX contracts at the current market price, a layered approach allows companies to work a blended average hedge rate to help cushion changes in cash flows and significant FX market volatility.

Rate Driven Layered FX Hedging

Layered Hedge Contracts

It is often useful to add automated processes, such as market orders which add new contracts as specific market rates become available.

Thus, as the market rate improves, the blended average hedge rate increases and additional cover is added.

If the live market rate moves unfavourably then the company utilises existing hedging contracts as a cushion.

The challenge with this approach is a continuous unfavourable exchange rate trend would leave the company utilising outstanding contracts and not maintaining a suitable level of risk cover.

As a result, it is appropriate to review hedge cover at regular

Hedging Intervals

Layered Hedge Rebalancing

To ensure an appropriate level of risk management cover is maintained, it is useful to review hedge level at regular intervals.

If there is an unfavourable FX market trend over the period, then often a decision to add minimum levels of new FX contracts is relevant.

If there has been a favourable FX market trend over the period, then often automated market orders will have automatically added new FX contracts and improved the overall blended average hedge rates.

In this scenario it is still relevant to review hedge levels at regular intervals to ensure maximum hedge levels are achieved and there is no over-hedging.

 

The Use of Layered FX Hedging by Corporates

FX Risk Management for Corporates

For businesses who are dealing with foreign currency exchange, hedging is an important strategy to maintain company commercial margins and costs.

Hedging is a risk management tool used to protect business exposures from the uncertainty of changing currency market prices. Businesses operating globally and in foreign currencies are exposed to the risk of sudden changes in FX values that can cause significant costs and loss of margins for those without effective strategies in place. Therefore, understanding how to properly use hedging strategies can help protect international businesses from unfavourable exchange rate movements and help keep margins stable.

At GSFX, we value a layered approach to hedging for our clients to review and maintain hedging levels and take advantage of favourable market trends. We aim to break down the reasons why, and discuss key elements to a layered hedging strategy for companies looking to protect their FX budgets from currency risk and volatility over period of time.

Corporate FX Layered Hedging

Corporate Foreign Exchange Layered Hedging

Layered foreign exchange hedging is a technique to manage international currency exposures. It involves deploying multiple layers of hedges, such as forward contracts, options and structured derivative instruments, in order to reduce the risk associated with fluctuating exchange rates. These risks include higher business costs and lower commercial company margins. By employing layered hedging strategies, companies can manage the risks of market conditions and protect the cost of their foreign exchange transactions.

Layered foreign exchange hedging is an effective tool for managing currency risks. Companies can use it to protect themselves from unexpected and unfavourable movements in exchange rates, whilst also taking advantage of potential favourable exchange opportunities offered by volatile FX markets, improving the overall blended average hedge levels. Furthermore, layered strategies offer flexibility and scalability so that businesses can adjust their hedge positions according to changing market conditions and corporate requirements. In this way, a layered hedge strategy can help provide an effective cushion again unfavourable exchange trends, whilst allowing a company to improve average hedge levels when FX markets trend favourably.

Corporate FX Hedging

Different Approaches to Corporate Foreign Exchange Hedging

As with all business practices and industries, there is not one single approach to hedging that is suitable for every business. Instead, a different approach is necessary depending on business targets, industries and market conditions. Importantly, businesses must also consider their pricing flexibilities, business contracts and commercial margins when choosing a hedging strategy.

Take a service business, for instance, where pricing is an important factor in competitive advantage and where pricing therefore cannot be used as a hedging strategy and adjusted based on changes in market conditions.

In case of significant FX market swings, a single large FX hedge contract would only protect against FX volatility until it expired. The business would also have to rely on forecast accuracy which may lead to under or over hedging. Following its expiration, the price would have to change in line with the new currency exchange. Would the business have flexibility to re-negotiate pricing with customers at that stage? This will determine how approach a specific project based hedge is to protect margins.

A layered hedging approach is particularly useful when used to protect forecasts cashflows over a longer period of time. FX market can move substantially over a 12 month period and beyond. Thus layered cover helps both cushion unfavourable exchange fluctuations and allowing blended average participation in favourable movements. Sometimes taking on a large single hedging over 12 month can leave a company committed to a substantially less favourable exchange rate when compared to the live market price.

A layered hedging policy usually begins with an exposure forecast over a medium-term horizon, often between 12 to 18 months in line with organisational pricing structure, business contracts, targets and corporate budgets. A number of hedges are then executed and then added to in a layered approach over time and at regular intervals to ensure a gradual smooth and blended average hedge price over the time period.

The hedging intervals of a layered FX hedging approach can be infinitely adapted to each companies targets and business objectives. FX cover might be reviewed daily, weekly, monthly or quarterly for example.

 

FX Hedging Policy

Reviewing a Companies FX Hedging Policy

For businesses trading internationally, foreign exchange risk hedging is a critical part of corporate financial strategy. It is important that firms monitor and review their FX hedge strategy regularly to ensure it is meeting their objectives and performing in line with expectations and goals.

Reviews and backtesting help businesses plan future strategies and adapt to changing commercial and FX market conditions.

It is important that companies fully understand the implications of FX hedging before placing any risk management contracts. An effective currency hedging strategy requires careful consideration and analysis of possible scenarios that could affect the businesses financial position. FX hedges create commitments which could potentially result in as greater risk to the business as the underlying exposure. It is important to ensure products and strategies are fit for purpose and manage exposures appropriately.

Naturally, not every business has the resources to efficiently manage and review an FX hedging strategy and policy in house. Working with a specialist FX provider can often help firms  create and execute FX hedging whilst minimising resource requirements.

FX Hedging Programs

Foreign Exchange Hedging Programs

GSNFX is a bespoke foreign exchange risk management provider. We develop hedging programs for companies to manage Corporate FX risks. Our years of experience in the FX markets give us a unique insight into strategies such as layered hedging.

Layered FX hedging at GSNFX is a useful tool for companies exposed to material currency exposures. The ultimate goal of any risk management approach is to protect downside risk against unexpected currency movements.

Layered FX hedging allows companies to take a more strategic approach to protecting commercial margins from adverse foreign exchange movements. It help companies adapt to changes in business levels and exposure levels, using regular reviews. It also helps companies adapt to changes in cash flow forecasts and expected future FX requirements.

If you are investigating implementing a layered FX hedging strategy, please reach out to us for a discussion in the first instance.

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