2016 risk management practices survey
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2016 Risk Management Practices Survey
Foreign Exchange
2
Table of contentsExecutive summary 4
FX risk management challenges 7• Attitudes about FX risk management 8• Risk management policies 9• Risk quantification 10• Significant challenges 11
Leading practices in FX risk management 12• Balance sheet exposures 13• Forecasted transactions 18• Translation exposures 25
Additional FX risk management practices 26• Budget rates 27• Centralized risk management 28
Appendix: Survey participant information 29• Survey participants 30• Currencies traded 32• Foreign subsidiaries 33
Summary and conclusion 34
3
FX Risk Management Practices SurveyWells Fargo Foreign Exchange has been surveying companies large and small, public and private, for eight years to gather information about the type of foreign exchange risk these companies face and how they manage it. The findings in this report provide valuable insights for our clients and prospects in developing benchmarks and strategies around foreign exchange (FX) risk. These findings also help Wells Fargo shape its product and service offerings so we can most effectively help our clients meet their financial needs and succeed financially.
We truly appreciate the contributions of the participants who provided the responses necessary to yield comprehensive and meaningful survey results. We hope you find the survey’s contents informative and useful in measuring or establishing your own company’s policies around FX risk management.
2016
FX Risk Management Practices Survey | 3wellsfargo.com
Executive summary
FX Risk Management Practices Survey | 5wellsfargo.com
Since our 2014 survey, significant volatility in the FX markets has put more pressure than usual on corporate hedge programs, with companies often highlighting the effects of FX in their quarterly earnings releases. The 2016 FX Risk Management Practices Survey results show how companies responded to this market environment. The results also reflect many of the reoccurring challenges faced by corporations attempting to manage FX risks consistent with a best-practices approach, as well as leading practices in FX risk management.
Greater concern regarding FX risksIn response to the significant market volatility during the past two years, 55% of our respondents indicated that FX had become a greater concern for them. In response, they took the following actions:• 47% indicated that they had increased the amount of
their exposures hedged• 29% indicated that they had developed or revised
their FX risk management policies • 18% extended their hedge horizons• 13% changed the mix of hedging instruments used
Corporations continue to be challenged by FX risk managementThe results of our survey also highlight the recurring challenges corporate hedgers face in attempting to manage FX risks consistent with a best-practices approach:• A significant number of companies (36%) indicated
that they had no formal policy to address FX risks• Only 17% of corporate respondents indicated that they
measured potential FX risk. With so few companies quantifying and reporting risks to senior management, this points to a lack of oversight and control
• Of the companies that do not hedge forecasted transactions, significant reasons for not hedging include forecast inaccuracy (33%) and a general lack of expertise and resources to manage a cash flow hedge program (23%)
• 53% of all companies stated that their biggest obstacle to establishing FX risk management best practices was deciding when to hedge and choosing the right strategy; this result, more than any other, is indicative of the corporations’ unpreparedness in regard to their FX risk management programs
Leading practices in FX risk managementWe asked our customers basic questions regarding their hedge programs. The following results offer insights into which exposures companies hedge, how they hedge them, and why.
Exposures hedgedWhen asked about the exposures they hedge, our respondents indicated:• Three out of four companies (76%) hedge foreign
currency balance sheet positions• Six in 10 companies (63%) hedge forecasted
transactions• 10% hedge their net investment risk
• 15% hedge earnings translation risk
More than half (55%) of respondents report that foreign exchange became a greater concern for them in the past 12 months.
55%
6
Leading practices in FX risk managementHedge accountingFor hedges of forecasted transactions, hedge accounting is employed frequently by public firms (82%), compared to just 37% of private firms. Companies with revenues exceeding $500 million are more likely to elect hedge accounting than smaller companies.
Hedging instruments used• The use of forward contracts is nearly universal
among those who hedge• 97% use forward contracts for balance sheet hedges,
and 92% use them for forecasted transaction hedges• Purchasing options is less prevalent, with only
9% of companies purchasing options for balance sheet hedges and 13% purchasing them for forecasted transactions
Budget rates• Almost all public companies (91%) set budget rates
as part of their formal planning process, compared to just 67% of private companies
• 49% of respondents indicated that they set budget rates based on current market rates (spot or forwards) or a blend of actual hedge rates
• 42% indicated that they set budget rates based on consensus forecasts
Hedging strategy • Two-thirds of respondents (67%) say they manage
risk systematically compared to active or dynamic hedge programs
• Most companies (85%) manage risk on a centralized basis
• 40% cite a maximum hedge horizon for forecasted exposures of 12 months, but 42% hedge to longer maturities
• For hedging forecasted transactions, companies describe their objectives either as reducing risk to both cash flows and earnings (35%), limiting risks to cash flows and margins at the entity-level (32%), or reducing earnings risks (31%)
Hedge objectivesThe top three hedge objectives identified by our respondents are, in order: 1. Smoothing the effect of changes in FX rates
over time2. Protecting budgeted results3. Helping senior management forecast the company’s
financial performance
Most companies that hedge forecasted transactions will hedge these exposures for 12 months or longer.
82%
FX risk management challenges
8
Heightened currency volatility has intensified concerns about FX risk management
Unchanged
Greater concern
Reduced concern
7%
55%
38%
Attitude toward FX risk management Changes made to risk management approach
3%Shortened the average maturity of hedges
7%Decreased the amount of exposure that is hedged
13%Altered the mix of hedging instruments used
18%Extended the average maturity of hedges
Increased the amount of exposure that is hedged47%
29%
16%
6%
Developed/revised FX policy
Other
None
26% Improved/enhanced systems
FX Risk Management Practices Survey | 9wellsfargo.com
Effective risk management is hindered by the absence of formal FX policies . . .
Respondents that have a formal written policy:• While 64% of survey participants have a formal written FX policy, roughly one in three do not• Large firms and public firms are more likely to have written policies
64%Total
88%
47%
Public
Private
44%
81%> $500 million
< $500 million
Revenues
10
. . .and by a lack of regular and comprehensive risk quantification
Methods used to quantify FX risks
Respondents that use a quantitative or statistical methodology to measure risk
Companies with revenues of $500 million or more are more likely to employ quantitative and statistical methodologies than companies with revenues of less than $500 million.
24% vs. 8%
Of the firms that employ quantitative methods, companies with revenues of $500 million or more use the Value at Risk methodology more often than companies with revenues of less than $500 million
62% vs. 18%
17%Total
• Most of the survey participants that quantify risk use several techniques, with sensitivity analysis the most common
• Only 17% of survey respondents regularly quantify their exposure to FX risk
Other
26%
10%
Public
Private
Scenario analysis
Value at risk (VAR)
Sensitivity analysis
52%
6%
52%
67%
* Caution: low base size
FX Risk Management Practices Survey | 11wellsfargo.com
In this environment, determining when and how to hedge FX exposures remains a significant risk management challenge
Greatest FX risk management challengeHalf of the survey respondents cited market volatility, when to hedge, and identifying the proper strategy as their greatest challenge.
Market volatility, when to hedge, and using a proper strategy
Accuracy and timeliness of data
Approvals, communications, and internal resources
Hedge accounting and compliance
Other
Public companies (33%) are more likely than private companies to cite accuracy and timeliness of data as the greatest risk management challenge, as are large companies with revenues of $500 million or more (28%).
Public/>$500 million22%
11%
13%
53%
1%
12
Leading practices in FX risk management
13
Balance sheet positions remain the most commonly hedged exposure
Type of non-functional assets or liabilities on balance sheet
Companies that hedge non-functional currency booked assets or liabilities
Three-fourths of companies with trade-related assets or liabilities on their balance sheet hedge foreign currency positions, as do two-thirds of those with finance-related assets or liabilities on their balance sheet.
Roughly three in four hedge nonfunctional currency booked assets or liabilities, compared to 71% in 2014.
76% vs. 71%
76%Total
Finance-related
75%
66%
Trade-related
Finance-related
Trade-related 92%
61%
FX Risk Management Practices Survey | 14wellsfargo.com
Of the respondents hedging balance sheet positions, half hedge between 75% and 100% of their exposures; hedge horizons are typically 3 months or less
More than half of the survey participants that hedge balance sheet positions cover at least 75% of their exposures.
Balance sheet hedges predominantly have horizons of three months or less.
Percentage of balance sheet positions hedged
Maturities of balance sheet hedges
Hedge horizon
Trade-related
Finance-related
15%16%
53% 51%
75% or moreLess than 25%
15% 17% 17%
25% to less than 50%
16%
50% to less than 75%
Trade-related
Finance-related
58%67%
Less than 3 months
16% 14%
3 to less than 6 months
26%19%
6 months or more
15
The use of forward contracts for hedging balance sheet positions remains nearly universal
Balance sheet position hedge instruments
Forward contracts
11% 9%Purchased options
9% 7%Option collars
7% 9%Cross-currency swaps
5% 4%Participating forwards
1% 2%Forward extras
3% 4%Other
97%98%
20162014
Forward contracts
5% 9%Purchased options
6% 6%Option collars
10% 7%Cross-currency swaps
3% 4%Participating forwards
3% 1%Forward extras
4% 4%Other
96%90%
Finance-related Trade-related
Forward contracts are used for both finance- and trade-related positions
FX Risk Management Practices Survey | 16wellsfargo.com
Survey participants tend not to apply special hedge accounting to hedges of balance sheet positions
Hedge election for hedges of balance sheet positions
2014
2016 30%
33%
2014
2016 29%
36%
Trade-related
Finance-related
• Only one in three firms that hedge balance sheet positions elect hedge accounting
33%Total
17
The reasons for not hedging balance sheet items include small and/or uncertain exposures and limited resources
• Small exposure size is most often cited as a reason for not hedging • Exposure uncertainty and resource constraints are also important factors
Risk of exposures is small
Trade-related
Constrained resources to manage the positions effectively
Settlement of accounts payable/receivable is uncertain and we wish to avoid cash settlements on balance sheet hedges
Hedge costs are too high
Lack of the ability to track and understand the size of the risks
Other
49%
27%
18%
13%
16%
24%
Risk of exposures is small
Finance-related
Intercompany loans are classified as long term in nature
Timing of repayment of loans is uncertain and we wish to avoid cash settlements on rolled hedge contracts
Hedge costs are too high
We designate FX-denominated liabilities as a hedge of our foreign net investment
37%
34%
We are constrained by credit2%
Other12%
7%
12%
32%
Factors influencing the decision not to hedge balance sheet positions
FX Risk Management Practices Survey | 18wellsfargo.com
Factors influencing the decision not to hedge balance sheet positions
Nearly two in three survey participant firms hedge forecasted transactions
Companies that hedge forecasted foreign currency revenues and/or expenses
63%Total
Private 62%
65%PublicThe percentage of participants hedging forecasted transactions (63%) exceeds the finding in our 2014 survey (59%), and both private and public firms appear to have increased the hedging of forecasted transactions (59% and 60%, respectively, in 2014).*
63% vs. 59%*
* Because of changes in the wording of survey questions, these comparisons likely represent conservative estimates of the increased hedging of forecasted transactions.
19
Of the respondents that hedge forecasted transactions, a maximum hedge horizon of 12 months is the most popular (40%), but another 42% hedge to longer horizons
% of forecasted transactions hedgedThe categories in the figure below represent average coverage ratios across hedges of all maturities. Companies typically hedge declining percentages of exposures at longer hedge horizons.
18%Less than 25%
19%25% to less than 50%
27%75% or more
36%50% to less than 75%
More than 40% hedge to a maximum maturity exceeding one year, and another 40% hedge to a maximum maturity falling between six and 12 months.
Maximum maturities for hedges of forecasted transactions
3 months or less
9%3 – 6 months
19%12 – 18 months
9%18 – 24 months
14%Greater than 2 years
8%
6 – 12 months 40%
FX Risk Management Practices Survey | 20wellsfargo.com
The use of forward contracts is nearly universal for hedges of forecasted transactions
Forecasted transaction hedge instruments
Forward contracts
Option collars
Purchased options
Participating forwards
Cross-currency swaps
Forward extras
Other
About one-third use other hedging solutions to hedge forecasted foreign currency transactions.
35%
92%
13%
13%
9%
9%
3%
1%
• Nearly all companies that hedge forecasted transactions use forward contracts• Non-forward hedge solutions are more common for forecasted transactions than for balance sheet positions
Provide a budget for option hedges
6%Total
Private Public
4%
10%
6%> $500 million
6%< $500 million
Revenues
• Few companies provide a budget for hedging with options
21
Firms that hedge forecasted transactions tend to have multiple objectives
Purpose for hedging forecasted transactions
Two-thirds of companies ranked smoothing the impact of FX rates on their company’s financial performance as one of their top three risk management objectives.
Objectives for hedging forecasted transactions
67%
53%
37%
Smooth the impact of changes in FX rates over time on our company’s financial performance
32%
11%
2%
Protect budgeted results
Assist in senior management’s ability to forecast our financial performance
Hedge rates are an important input to the pricing of our goods/services
Manage FX risks related to capital projects
Other
Top objectives (ranked in top three)
35% Protect both cash flows and earnings
32% Protect cash flows and margins at the entity level
31% Protect earnings at the consolidated level by hedging transactional cash flows
3% Other
FX Risk Management Practices Survey | 22wellsfargo.com
Hedge rates are an important input to the pricing of our goods/services
When hedging forecasted transactions, survey participants tend to take a systematic approach and often layer their hedges
Approach to hedging forecasted transactions
Systematic risk management
Active hedging
Dynamic hedging
67%
26%
7%
More than half the survey participants that hedge forecasted transactions layer their hedges.
63%> $500 million
43%< $500 million
55%Total
Private Public
70%
44%
Use of layered hedge programs
23
In contrast to the accounting for hedges of balance sheet positions, hedges of forecasted transactions tend to be designated for special hedge accounting
Assistance with hedge accounting
Nearly one in three companies utilize assistance from their banking partner.
Accounting/ audit firm25% Internal
software13%
Banking partner35% Other3%
Third-party vendor software30% None17%
Elect special accounting for hedges of forecasted transactions
• More than half elect hedge accounting• Public and large companies are more likely to do so
57%Total
82%Public
37%Private
33%
74%> $500 million
Revenues
< $500 million
The average monthly rate is the most common accounting convention for foreign currency denominated transactions. The average rate for the month
Other
The prior month-end spot rate
The daily spot ratePublic companies use the prior month-end spot rate more often than private companies.
33% vs. 21%39%
26%
28%
7%
Accounting convention for booking (P/L) rates
FX Risk Management Practices Survey | 24wellsfargo.com
Internal software
None
The reasons for not hedging forecasted transactions include small exposures, forecast uncertainty, and limited resources
Exposures are small
We are unable to accurately forecast our exposures
We lack the expertise and resources to hedge our forecasted exposures effectively
Hedge accounting is difficult
Our senior management does not believe in hedging
We do not fully understand our risks
42%
33%
6%
12%
17%
23%
Other15%
Factors influencing the decision not to hedge forecasted revenues and expenses
25
Hedging foreign net income and equity net investment translation exposures is less common than hedging balance sheet positions and forecasted transactions
Hedging equity net investment in foreign subsidiariesA minority of companies hedge, or in the past have hedged, their equity net investments in local currency functional subsidiaries.
Hedging translated value of foreign currency net incomeOne in seven companies report hedging the translated value of foreign currency net income.
Currently hedging equity net investment in foreign subsidiaries
Currently hedging translated value of foreign currency net income
Currently hedging or in the past hedged the translated value of foreign currency net income
10%
15% 21%
Total
Total Total
Private
Private Private
Public
Public Public
14%
5%
15%15% 23%18%
Currently hedging or in the past hedged the equity net investment in foreign subsidiaries
24%Total
Private Public
34%
14%
Additional FX risk management practices
27
Most firms set FX budget rates, and the approaches used vary
Source of budget rate*• Three-fourths of the survey participants set budget
rates, typically on an annual basis; public firms are more likely to set budget rates than private firms
• Firms use various methods to establish budget rates, but the most common single approach involves the use of consensus forecasts
• Because forecasts may not represent actionable market rates, their use may interfere with effective risk management
Set FX budget rates
77%Total
Private Public
67%
91%
42%37%
Consensus forecasted rates Prevailing spot rates
2016
2014
In 2016, public companies are more likely to use prevailing spot rates (34% vs. 17% of private companies) and private companies are more likely to use consensus forecasted rates (48% vs. 38% of public companies) when determining budget rates.
27% 27%
Blend of existing hedge rates Other
9%13% 4% 4%
9%
Prevailing forward rates Historical average rates
16%10% 9%
* Only includes responses if the company has non-functional assets or liabilities on their balance sheet or if the company has subsidiaries in foreign jurisdictions.
FX Risk Management Practices Survey | 28wellsfargo.com
Most companies manage FX risk on a centralized basis, and require a minimum credit rating for FX counterparties
Rely on centralized risk management
85%
Total
Private Public
81%91%
81%
89%> $500 million
< $500 million
Revenues
• Companies of all descriptions manage risk on a centralized basis
In 2016, public companies are more likely to manage FX risk on a centralized basis (91% vs. 81% for private companies), as are companies with revenues of $500 million or more (89% vs. 80% for companies with revenues of less than $500 million).
91% vs. 81%
Require a minimum credit rating for counterpartiesMinimum credit ratings for counterparties are more likely required by public companies and by those with revenues of over $500 million.
39%< $500 million
69%> $500 million
60%
TotalRevenues
67%
49%
Public
Private
Appendix Survey participant information
30
Survey participants
87%
13%
Parent company location
U.S.
Non-U.S.
Company annual revenue
Less than $100 million $100 million to < $500 million
$500 million to < $1 billion $1 billion to < $5 billion
Greater than $5 billion29%
26%
19%
13%
13%
FX Risk Management Practices Survey | 31wellsfargo.com
Manufacturing
Other Finance/Insurance3%
Technology13%
40%
Retail7%
23%
Wholesale trade14%
Yes
Public
No
Private
Have foreign subsidiaries? Industry
Public vs. private companyTitle within company
Other
Controller/Account Manager
Treasurer/Assistant Treasurer
12%
35%
15%
43%57% Finance Manager/Cash Manager17%
CFO22%
28%
72%
32
Currencies traded
Top currencies traded (ranked in top three)
78%
45%
32%
7%
4%
4%
2%
1%
1%
1%
16%
EUR (euro)
CAD (Canadian dollar)
GBP (British pound)
12% AUD (Australian dollar)
17%
17%
17%
JPY (Japanese yen)
MXN (Mexican peso)
CNY (Chinese yuan)
BRL (Brazilian real)
INR (Indian rupee)
CHF (Swiss franc)
SEK (Swedish krona)
NOK (Norwegian krone)
DKK (Danish krone)
NZD (New Zealand dollar)
Other
FX Risk Management Practices Survey | 33wellsfargo.com
Foreign subsidiariesForeign subsidiaries most commonly operate in the euro region of Europe, Canada, the UK, and China.
Regions where foreign subsidiaries operate Subsidiary functional currency
Europe (euro region)74%
U.K.65%
China60%
Canada67%
Other Asia/Pacific Rim41%
Mexico52%
Australia49%
Brazil45%
Japan46%
Europe (non-euro region)38%
India37%
Other South America23%
Middle East23%
Africa23%
New Zealand20%
Central America17%*Caution: small base size
Local/foreign currency
U.S. dollar
Japan
9%
91%
India
11%
89%
Brazil
17%
83%
New Zealand*
14%
86%
Europe (non-euro)
10%
90%
China
20%
80%
Other Asia/Pacific Rim
27%
73%
Other South America*
21%
79%
U.K.
12%
88%
Europe (euro)
12%
88%
Australia
13%
87%
Africa*
17%
83%
Canada
19%
81%
Mexico
28%
72%
Middle East*
19%
81%
Central America*
36%
64%
34
Summary and conclusion
The U.S. dollar has risen by approximately 25% in the two years since the Wells Fargo Risk Management Survey was last conducted. The 2016 survey solidifies the view that this move in the dollar has created a heightened concern around currency moves for many companies, and indicates that these companies have responded by hedging a greater portion of FX exposure. This year’s survey provided many observations about how companies are measuring and addressing FX risk, as well as what they perceive as some of the biggest challenges to managing FX risk. The survey also sheds some light on how perceptions and actions around FX have changed during the course of this very volatile period in the currency markets.
We hope the results and analysis presented in this report help you and your organization in your pursuit of optimal risk management strategies. We welcome any feedback or questions you may have related to this survey.
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Contact usFor additional information about our risk management solutions, contact your local Wells Fargo Foreign Exchange Specialist:
Legal disclosures
Some of the information or opinions stated in this survey may have been obtained or developed by Wells Fargo from sources outside Wells Fargo. In such cases, Wells Fargo believes the information or opinions to be reliable. However, Wells Fargo will not have independently confirmed the reliability of such information or opinions and does not guarantee their accuracy or completeness or the reliability of their sources. The information and opinions in this survey, whether or not they were obtained or developed from outside sources, may not be appropriate for, or applicable to, some or any of your activities or circumstances. As a result, Wells Fargo makes no express or implied promises, commitments, guarantees, representations or warranties with respect to any of the information or opinions in this survey, including, without limitation, any warranty as to completeness or accuracy or any express or implied warranty of fitness for a particular purpose, and Wells Fargo assumes no liability for any loss that may result from your reliance on any such information or opinions. In providing the information and opinions in this survey, Wells Fargo is not giving you any economic, tax, accounting, legal or regulatory advice or recommendations, and is not acting in a fiduciary relationship with you. Before using or acting on such information or opinions, you should seek your own independent professional economic, tax, accounting, legal and regulatory advice and conduct a thorough and independent review of any transaction or strategy in light of your particular circumstances.
© 2016 Wells Fargo Bank, N.A. All rights reserved. WCS-1936622
2016 Risk Management Practices Survey
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