3-minute read
Currency markets are unpredictable and can be highly volatile. Exchange rates are driven by an enormous array of factors - read more in our blog post here: https://okumarkets.com/blog/price-drivers/ - and, companies dealing internationally face financial losses and business disruption if currency fluctuations aren't avoided.
One of the biggest risks to a business failing to effectively reduce its currency risk is the dangerous injection of a decision-maker's market view into the firm's currency strategy. Without a clear plan in place, a company is exposed to emotional decision-making, markets-based decisions, and the potential to become over- or under-hedged as a result of these bad decisions.
This is where an FX Policy comes in...
What is an FX Policy?
An FX Policy is a formal document that outlines the processes, procedures, and guidelines for how a company manages its currency risk management strategy and trading operations.
The Policy document itself needn't be a long, ultra-sophisticated, and complex manual; it can easily be one-or-two pages that outline the who, what, when, why, and how of your business' currency processes.
What goes into an FX Policy?
As a bare minimum, we suggest the following items for every Policy:
- Risk Quantification – how are you quantifying your FX risk?
- Risk Mitigation – what's your strategy for reducing your FX risk?
- Risk Reporting – how and how often will you report on your progress?
- Approvals – for personnel, counterparties, financial instruments, limits etc.
One of the key advantages of working with a Policy is that it brings process and a clear mandate of what to do when and how to do it. Companies operating with an FX Policy benefit from shared accountability and are less exposed to the bad decisions of one individual.
Harry Mills, CEO Oku Markets
What else could the Policy include?
If you wanted to take things a stage further, you might consider the below:
- Definitions – for terms within the document
- Scope and Objectives – what are you trying to achieve?
- Identified Risks – all sources of currency risk within the organisation
- Risk and exposure limits – trading limits and counterparty exposures
- Controls and monitoring – controls/metrics for monitoring risk levels
- Accounting procedures – treatment of derivatives for accounting
Why you need a Policy
There are some obvious benefits from operating a Policy, with the financial and business performance aspects chiefly in relation to the Strategy you adopt:
- Earnings protected from currency fluctuations
- Profit margins protected from currency volatility
- Cash flow stability and predictability
- Improved budgeting and forecasting
But there are other, non-financial benefits that you should be aware of:
- Builds investor confidence
- Demonstrates strong governance
- May provide a competitive advantage
- Eliminates key-person risk/reliance on one person
- Reduced risk of poor/emotional decision-making
If you are the financial decision-maker in your business, then you will benefit by sharing accountability and gaining Board sign-off on a formal FX Policy. FDs and CFOs often face internal pressure from other stakeholders who may have a market view. Additionally, FX brokers will push for trades that might not be in the best interests of the business so, working to a Policy will give strict parameters for trading that will avoid these risks.
Would you like help building your own FX Policy?
We will do all the work for you, including risk quantification, strategy testing and design, policy creation and implementation, and ongoing reporting and performance evaluations.
You can contact us for a review of your currency processes and for our guidance and suggestions at [email protected] or 0203 838 0250.
Thanks for reading 👋
Frequently Asked Questions
1. How can an FX Policy help businesses stay competitive in the global market?
An FX Policy enables businesses to effectively manage currency risks, ensuring stable profit margins and predictable cash flows. By reducing the impact of currency fluctuations, companies can maintain competitive pricing and financial stability in the international marketplace.
2. Is an FX Policy suitable for small and medium-sized enterprises (SMEs)?
Yes, an FX Policy is beneficial for SMEs as well. Regardless of the size of the business, currency volatility can impact financial performance. Having an FX Policy in place helps SMEs safeguard their earnings, manage cash flow, and demonstrate to stakeholders their commitment to prudent risk management.
3. Can an FX Policy prevent all currency-related risks?
While an FX Policy is an essential risk management tool, it cannot completely eliminate all currency-related risks. However, it significantly reduces exposure to currency fluctuations and provides a structured approach to handling risk, thereby minimizing potential adverse effects on the business.
4. Is it necessary to revise an FX Policy regularly?
Yes, regular revision and updates to the FX Policy are essential. Currency markets and business conditions change over time, and new risks may arise. Periodic review and adjustment of the policy ensure it remains relevant and effective in addressing the evolving currency risk landscape. Good news: Oku Markets can do this for you.
5. What role does the board of directors play in implementing an FX Policy?
The board of directors plays a crucial role in the FX Policy's implementation and oversight. Their sign-off on the policy demonstrates a commitment to sound governance and risk management practices. Additionally, the board may review reports on risk exposure and performance evaluations, providing strategic guidance to ensure the policy's effectiveness.
6. What are the potential consequences of not having an FX Policy?
Without an FX Policy, businesses may be more susceptible to financial losses due to unpredictable currency movements. Lack of risk management can lead to eroded profit margins, cash flow instability, and compromised decision-making during currency fluctuations.
