Hedging Policy Creation: Case Study

 

Overview

Why a well-documented treasury policy is vital

Our client was looking to external investors to raise money and wanted to demonstrate discipline and prudence, even whilst running a high growth business. 

We had been working with this client for a little under a year when they said they wanted to formalise their processes and documentation. They’re a fast-growing retail business, with sales in Europe and the US, and manufacturing in the UK, so a lot of currency sensitivity and multiple income streams. 

Their underlying business strategy was to continue to raise funds to support and accelerate their growth plans. Their view was that a business with a well-documented strategy and process is more appealing to a wide range of investors and could lead to a better valuation. 

 

Client challenges and solution

Existing hedging strategy

The client’s hedging strategy and process was sound. They are a lean team with a low-risk threshold, and so they use vanilla forwards with some flexibility built in to enable them to use their cashflow more efficiently. As a growing business, their forecasting wasn’t as accurate as they would like it to have been, so we allowed for that when we came to book the correct amount of FX coverage. 

Their clients pay on a combination of short terms or on a pro-forma basis and they set their budget rate annually but update quarterly if their realised rates deviate by more than 5%. 

Policy creation

With this information, we had already structured a large part of the policy, and it was a case of documentation using a straightforward formula: 

• Identifying the risks that you face
• Establishing your appetite for each risk
• Agreeing how you manage each level of risk
• Assigning who manages risk, and which counterparties you manage it with
• Reporting on the risk, including: who, how, and what for?

We know that the risk comes from receiving foreign currency income and having exposure to the FX market, as well as a possible variation against the company’s internal budget rates – so we formalised how they might determine their budget rates.

Margins and risk 

With fine margins, we know that risk appetite is limited. With forecasting being developed, we used some of their limited appetite to consider the size of hedges, rather than taking risk to try and improve the overall rates achieved. 

Reporting and controls

Having defined responsibilities and sign off in a small team is important and provided best practice. 

Reporting on risks being managed, how the policy is performing and areas that can be improved became a quarterly instance along with a planned annual deep dive ahead of the next year’s sign off. 

 

Implications and outcomes

Why formalising process still adds value

Formalising a process that is already effective can sometimes be deprioritised in a busy, growing business. However, building strong foundations with process and documentation is important for businesses wishing to scale their growth.