Given how complex FX risk management can be, getting it right is no small feat. According to a recent Global Treasury Survey conducted by Deloitte, FX volatility is among the top challenges facing treasurers today.
FX hedging strategies help companies mitigate the risk of exposure to foreign currencies. Two of the most common hedging options are balance sheet hedging and cash flow hedging.
Let’s dive into the basics of balance sheet hedging to learn more about how it works, how it helps avoid FX disaster, and how to make balance sheet hedging more successful.
What is Balance Sheet Hedging?
Balance sheet hedging reduces the impact of FX rate changes on a company’s financial position. It aims to stabilize reported assets and liabilities, mitigating volatility caused by FX fluctuations.
Companies prioritize balance sheet risk management as existing internal mechanisms, such as price adjustments, can’t protect against FX volatility of items already on the balance sheet. Unhedged assets and liabilities directly affect the bottom line. Re-measuring assets and liabilities in different currencies into the functional currency each month is required of every company. The goal of a balance sheet hedging program is to offset this impact.
The net impact of currency remeasurement combined with the offsetting balance sheet FX hedges provides the company feedback each month on how well they manage this risk. However, without the ability to break down the potential sources of variance, the company is just left with an unexplained delta between the underlying balance sheet exposure and the balance sheet hedge.
The FX risk manager hopes this difference is not large and that they will not have to scramble to try and explain where the noise is coming from during a tight month-end close window. Hope, however, is not a strategy. Companies need full visibility into their FX exposures and the sources of variance of their balance sheet hedging program.
Want a deeper dive into hedging FX risk? Learn more about the difference between balance sheet hedging and cash flow hedging and overcoming their common challenges. Download the white paper.
Getting Balance Sheet Hedging Right Must be a Top Priority
Proactive and accurate balance sheet hedging is essential for companies to navigate FX risks effectively and maintain their financial well-being.
To overcome the common challenges faced in balance sheet hedging, companies can invest in technology solutions to automate and streamline hedging activities. Without the right support, it’s too easy for manual errors, data integrity issues, or a lack of communication to lead to a bad surprise on the balance sheet. In the end, you don’t know what you don’t know.
Automating hedging processes can reduce errors, increase efficiency, and improve accuracy. This may involve software solutions that provide insight into your FX exposure data, automate FX hedging workflow, and provide risk reporting and analysis capabilities.
When it comes to FX, fluctuations leading to losses are inevitable—but with the right process and technology, companies have a better chance of predictable outcomes with minimal risk. By putting solutions in place that address common balance sheet hedging challenges, you can mitigate the impact of FX volatility and protect your bottom line.
If overcoming these challenges seems like a daunting task, AtlasFX can help.
