FX concerns will dominate the thoughts of many treasurers in 2023. Eric Huttman, CEO, MillTechFX, explores three key trends that will be shaping the response.
After a period of relative calm in 2021, volatility dominated the FX market throughout 2022. Driven by high inflation, rising interest rates, and geopolitical issues, the dollar soared to 20-year highs, while the pound and euro slumped to 37- and 20-year lows respectively, only to then substantially bounce back during the last months of the year.
According to Kyriba’s October Currency Impact Report, firms in Europe and North America reported $37.27bn in currency headwinds in Q2 2022 alone. The pressure on corporates, a segment of the market that has traditionally struggled with their FX set-ups, intensified in this new environment. As a result, many are reviewing their FX processes to add in a layer of agility and flexibility so they can readily navigate this increasingly volatile climate.
With many treasurers now planning for the year ahead, here are three key FX trends that we at MillTech believe are likely to affect the way in which corporates manage their currency exposures in 2023.
1. Changing face of FX hedging
The main change corporates are making in the short term is increasing hedging activity. The task of FX risk management has – for many firms – gone from second order to a rapidly rising priority, with 89% of corporates that do not have a formal hedging programme in place now considering introducing one.
Firms are adapting their hedging strategies to protect themselves against rising volatility and uncertainty in the market. During calmer pre-Covid-19 times, some corporates moved towards more exotic products. In recent months, many have reverted to more straightforward linear products such as forwards, which are more liquid and easier for corporates to unwind should the market move against them.
An interesting dynamic is that while treasury teams are hedging a higher amount of their exposure they are reducing the length of their hedges. The average hedging ratio of 56% was discovered in a survey conducted by Censuswide on MillTechFX’s behalf between June 2022 and July 2022, based on a survey of 251 CFOs, treasurers and senior finance decision-makers in mid-sized corporates. Instead of locking in rates for 12 months or more for FX forwards, the average length of hedges is now five months. Shorter hedging lengths mean corporates have flexibility to adapt to the changing market rather than locking into a rate for a long time, enabling firms to adjust their exposure if they need to.
While there will be always be some firms that don’t hedge their FX risk at all, we should expect those that previously didn’t to begin doing so. Given the potential for the US dollar to weaken from its record highs over the past 12 months, this could be particularly important for US firms that may have a stronger incentive to implement more stringent hedging strategies in 2023.
For many corporates, FX processes are manual, cumbersome, and time-consuming. The MillTech survey shows that nearly two-thirds (65%) use manual execution processes and over a third (36%) still primarily use email for instructing financial transactions, while 29% rely on phone calls.
FX price discovery can often involve multiple phone calls, emails or online platforms to log in just to obtain comparative quotes from counterparties. Because the market is constantly moving, price discovery requires a team of people to collectively decide which of these counterparties can offer the best quote.
This entire process is a huge drain on time and resources. The 2022 MillTech survey indicates that corporate treasury teams spend around 1.85 days per week on FX-related matters, while nearly half (47%) spend two to three days on such matters.
These challenges have provided the impetus for corporates to begin embracing simple, tech-enabled solutions that digitalise these processes, with 89% of MillTech 2022 survey respondents now looking into new technology and platforms to automate their FX operations.
With corporates on the search for efficiency gains and cost savings, moving away from traditional providers and legacy processes towards more automated digital infrastructure is likely to be a prominent trend in the coming year.
Outsourcing has emerged as common practice across the financial services industry, and it is set to also gain traction in FX in the year ahead.
FX is one of the largest and most liquid markets in the world, but also one of the most complex. Setting up and onboarding new FX counterparties, centralising price discovery, and navigating the post-execution phase often have their own complications and can be a huge administrative burden for corporates, eating up much-needed time and resources.
For these reasons, treasury functions are moving towards external solutions that can assist with these steps; according to HSBC and Acuris, 44% of CFOs in larger companies have outsourced some of their day-to-day functions.
With the right partner, outsourcing frees up resources for more effective use elsewhere, enabling firms to dedicate more time to core business matters. The end product is also more likely to be of higher quality, leading to improved execution, saving both time and money in the long run.
There is growing recognition that outsourcing does not necessarily mean a loss of quality or control, and looking into 2023 we can expect more firms to harness third-party services as a way of saving time and money in their FX activities.
The road ahead
With currency volatility expected to continue well into 2023, FX is set to become an increasingly important priority for corporate treasury teams. Treasurers and CFOs who implement the right processes, and harness technology-driven solutions that can help achieve greater transparency and best execution, will be best placed to navigate the challenges that lie ahead.