Testing the Future: FX Scenario Modelling for All

3rd January 2024

Effective control of foreign transaction fee budgets means FX scenario modelling. Danny Ross, Managing Director, Argentex, a global payment and currency risk management specialist, tells TMI why.

Every business setting cost pricing or managing its budget with foreign transaction fees should at least consider implementing FX scenario modelling into its financial strategy. But according to Argentex’s online survey of 500 CFOs, treasurers, and financial controllers of organisations based in the UK, France, Spain, Canada and Australia, 47% have so far avoided doing so. For Ross, their inactivity is a missed opportunity to gain tighter control over what can be a material risk.

The survey, carried out in June 2023, polled businesses with more than £1m in foreign currency exposures per year. For such businesses, currency fluctuations can regularly impact profit margins, and these are often set in annual budgets, based on assumed exchange rates. It’s a risky assumption.

“But through forecasting different base cases, and seeing how certain rate changes will affect their costs and revenues, CFOs and treasurers are able to manage their currency risks effectively, and then hedge accordingly against the different scenario outcomes,” notes Ross. “In this case, scenario modelling should be seen as an insurance that any business managing international costs and budget needs to consider.”

Skills base

That being said, not undertaking FX scenario modelling typically comes down to a business not having the resources or experience to do so, Ross acknowledges. Indeed, smaller businesses may have only one employee managing all their finances. “With this responsibility, forecasting currency rate movements tends to fall outside of their remit, with other priorities and time pressures taking precedence.”

It is true that scenario modelling requires specialist knowledge of currency markets and risk. These skills are typically absent in smaller finance teams. “In these cases, firms can look at outsourcing their FX risk needs to a dedicated team that can act as an extended support function and undertake scenario modelling on their behalf,” suggests Ross.

Modelling matters

Many businesses seek to maximise profit by maintaining the highest possible margins. FX scenario modelling can support this objective, and help businesses achieve their intended financial goals.

The process involves creating a number of hypothetical situations or models that target the simulation of potential future scenarios. These might include changes in the economic environment, new strategic goals, different customer behaviours, or technological developments. The adjustment of a variable in a model, even to extremes (stress testing) can provide new insight into how each different scenario might play out, how the organisation’s finances might be impacted, and how different responses might create different outcomes.

As Ross explains: “Modelling different scenarios will predict how changing currency rates affect profit margins, and demonstrate how different hedging strategies will mitigate these changes. Consequently, it enables CFOs and treasurers to take appropriate measures to hedge against possible risks, achieve their desired profit margins, and potential opportunity gains.”

Of course, there is no one-size-fits-all approach to scenario modelling. FX scenarios will depend on a company’s risk appetite and objectives. While some may only want to mitigate against risks to their profit margins, others may actively seek to capitalise on FX gains. Within this broad context, scenario modelling can at least help forecast on different scales, and offer top and baseline options, points from which next steps can be better understood.

Easier access

Without the skills or systems in-house to enable FX scenario modelling, engaging a specialist partner as a dedicated support and resource makes finding solutions for FX needs easier, counsels Ross. As a support and advisory function, currency specialists and solution providers will undertake the modelling on a company’s behalf and should offer full transparency in their advice.

Ross concludes: “Scenario modelling is inherently difficult. But through speaking to risk-management experts rather than trying to undertake the task in-house, it becomes far more accessible, especially for smaller businesses.”

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Treasury Management International (TMI) is a well-respected and independent voice in the treasury world, renowned globally for its sharp editorial focus and breadth of opinion. With real-life experiences from practitioners, TMI showcases topical, pragmatic solutions and strategic insights providing valuable material for all practitioners, from experienced treasurers and CFOs to those new to the profession.

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