The problems are, of course, loudest in companies in commoditised businesses. With margins extremely thin, many of these companies had built up capabilities to run active treasuries with the goal of capturing a few percentage points of the forward premium to boost margins. In general, they have strong teams and, in some cases, also have documented risk management policies.
Unfortunately, in most cases I know of, the policy was followed mostly in the breach, since the promoters had grown accustomed over the years to making good money through foreign exchange position-taking. Worse yet, with the buyers' credit arbitrage window recently tightened, many of these players pushed ever more aggressively to capture those few percentage points - with an unsurprisingly painful impact when the tide went out.
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The larger of these companies often have pretty good information flow and, as I said earlier, strong market-savvy teams. The structural lacuna here is usually the clubbing of financing costs into the foreign exchange book. This confuses spot risk with forward cost risk, making it difficult to take hedge decisions, particularly when the market is trending adversely and stop losses are threatened.
Smaller companies in commoditised businesses were/are in even bigger trouble. Despite (in most cases) not being handicapped by promoters who fancy their ability to beat the market, these companies are often limited by structural issues like incomplete or non-timely information flow between the business divisions and the treasury. While this is sometimes simply the result of poor MIS, it is more often the result of the difficulty of making exposure forecasts, which sometimes leads to subterranean tension between sales or purchase and treasury. This is really a management issue and needs to be addressed front and centre.
At one such company we are working with, we very quickly recognised that accurate exposure information was a key problem. The treasury team told us that they get export sales data only one or two months in advance; information on imports, though, was much more readily available for longer tenors. The CEO, who attended one of the early briefings, believed that export forecasts should be available out to 12 months. The head of sales insisted that, given the volatile business environment, it was impossible to forecast sales more than three months ahead. The CFO, who wanted to ensure that his low-cost foreign exchange credit lines (which acted as a hedge to exports) were fully utilised, needed export forecasts out to the longest possible tenor.
Recognising that all parties were correct to different degrees, we had to develop a via media approach and nurse the different stakeholders to a happier medium. This was a time-consuming process, but we are seeing some progress.
Another interesting example is a billion-dollar-plus FMCG company we are working with that has strong margins and even stronger growth. Here, too, the promoters have a good understanding of, and taste for, markets. However, being much more professional, they have a well-thought-out risk management policy that is closely linked to the business and is even used to drive business performance. Unfortunately, here, too, there was a fundamental lacuna - they were managing the accounts and not the cash. However, since margins were so strong, they never noticed the gap until, of course, the music stopped in the last quarter.
Given their professionalism and skill, resolving this issue conceptually has been quite easy; translating it to maximum efficiency within its very complex business model is a continuing challenge.
And then, of course, there are companies where the CFO is continuously scrambling to raise capital. As a result, treasury risk management - and this is true for even multi-billion-dollar companies - ends up getting short shrift. In some cases - one in particular that I am thinking of - there is no real process to speak of and the company has been routinely reporting huge foreign exchange losses quarter after quarter.
Even where there are some processes - another example comes to mind - they are often not effectively tuned to contemporary practices in risk management. Balance sheet risk is confused with P&L risk, and the effort to naturally hedge liability payments with foreign exchange inflows without clear processes and strong discipline leads again to growing pools of red ink.
Huge market volatility, as we have seen recently, is often blamed for poor foreign exchange performance. However, as articulated above, in many cases this is simply a fig leaf that conceals failures in risk management. It ain't the market at all.
jamal@mecklai.com