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Amol Dhargalkar, Chatham Financial

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Forex volatility leaves companies more exposed than ever, says Chatham Financial

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Many businesses are failing to fully protect themselves against the most significant financial risks they face, according to a study from Chatham Financial.

The 2016 State of Financial Risk Management Study found that only 55 per cent of firms with exposure to currency risk actively manage this risk through the use of financial hedges.
 
The percentage of firms hedging their commodity and interest rate risk exposures is even lower, with just 49 per cent and 37 per cent, respectively, using derivatives to manage these risks.
 
The study, which analyses the 2015 financial risk management practices of more than 1,500 publicly listed corporations in the US, found that fewer companies are hedging currency, interest rate, and commodity risks than they were three years ago. The amount of companies employing hedges to manage their interest rate risks fell from 37 per cent in 2012 to 32 per cent in 2015. The number of overall companies using currency and commodity hedges fell three per cent each from 2012, and now sits at 37 and 20 percent, respectively.
 
The decrease in usage of financial risk management tools has emerged during a period of heightened volatility in global markets, especially in currencies.
 
“Given the tremendous levels of volatility in currency markets over the past several years, it's surprising to see that fewer companies are electing to hedge against exposures in this asset class,” says Amol Dhargalkar (pictured), managing director of Chatham Financial’s global corporate sector.
 
Slow growth in Europe, Canada, China and Japan, and recessionary environments in Brazil, South Africa and Russia, have had an impact on the ability of firms to forecast swings in FX rates. As a result, some firms – especially newer entrants to the global markets – are putting off hedging for the time being.
 
“This practice will likely continue until these firms feel comfortable in their ability to predict business patterns and forecasts,” adds Dhargalkar. “Unfortunately, this can result in the business being exposed to enormous downside risk as currencies fluctuate, be it from singular ‘shock’ events or longer-term trends.”
 
The decline in interest rate hedging activity, however, is to be expected.
 
“The zero interest rate policies of many major central banks, coupled with negative rates in Japan and across Europe, have resulted in a decline of hedging activity in this sector,” says Dhargalkar.
 
The study found that larger companies tended to have greater exposure to risks. For example, 75 per cent of large firms (those with annual revenues of USD5-USD20 billion) reported having FX exposure, with just 58 per cent of smaller firms (revenues of USD500 million to USD1 billion) stating so. However, smaller firms are equally less likely to hedge exposures to all forms of risk. While 69 per cent of large companies hedged their FX risks in 2015, just 39 per cent of small companies did so.
 
“Hedging programmes require sophisticated teams and dedicated resources, which just isn’t an option for many smaller firms,” says Dhargalkar. “Larger firms are naturally better positioned to plan and execute a robust internal hedging practice.”
 
The exposure faced by smaller firms can be especially dangerous in a volatile climate, as these firms tend to have fewer natural hedges against risks elsewhere in the business.
 
"While some firms are perfectly well-founded in taking a strategic 'wait and see approach' to hedging, many of those who don't hedge do so simply because of their inability to manage these rigorous processes internally," says Dhargalkar. "Third party practitioners such as Chatham Financial can work with these firms to provide financial risk management planning and execution that doesn’t require an outlay of additional dedicated internal resources.”
 
The study also quantified the widespread use of hedge accounting treatment, which is used by companies to reduce the profit and loss impact of derivatives usage. A strong majority of firms are utilising hedge accounting to manage at least one form of risk. Seventy six per cent of firms hedging forecasted revenue and expenses are utilising hedge accounting strategies. Additionally, 80 per cent of firms that hedge risks are applying hedge accounting to interest rate derivatives, and only 45 per cent are doing so for their commodity derivatives.

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