This month we look at Creating a Written FX Hedging Policy, where we examine the necessary key elements for writing an effective policy.
This article is useful for anyone looking to protect their business from foreign exchange risk. It helps to be familiar with the FX Hedging Cycle since a good policy is based around understanding this cycle. That said, you may find that formalizing your FX policy is simpler than you think. A written FX policy can be as simple or sophisticated as you wish.
The first step is to identify if you want or need a policy. At EncoreFX, we advocate having a clear plan, strategy, or policy that is well executed. There are many benefits to creating a policy; some of my favourites include:
We are also big advocates of formalizing plans by putting them in writing; a formalized policy removes any ambiguity about how individuals are to manage FX risk. Written plans also help create accountability.
It is worth noting that an FX policy does not have to be complicated. It could be as simple as ‘we will hedge a minimum of 50% of our forecast FX exposure out 6 months’ or ‘every sales order over NZD 100,000 will be hedged immediately’. Then again, it’s not always that simple. This article will explore some of those finer details.
There are other reasons why you might think about putting a policy in place, aside from just following best practice. Ask yourself:
If you’re keen on putting your FX policy into writing, read on.
Less-than-practical FX policies are common, ranging from ill-informed business decisions to hedge everything, to businesses believing they are better off covering nothing and seeing how things play out. Even expensive, multi-page FX policy documents are only as good as the individuals that have read and agreed to them. Conversely, what good is a single-page policy if all it does is stipulate that a business will ‘hedge against risk’ without providing a method as to how this should happen?
It’s natural for policies to vary significantly from company to company, but a good FX hedging policy will always answer four key questions that assist in practical implementation. These are:
A finance or treasury team will need to grasp these elements in order to execute on the policy.
Let’s say you are an importer and wholesaler of office furniture. You have a steady stream of orders and are importing USD 1 million worth of stock each month. Your policy could be this simple:
Writing a policy is not always straightforward, and is best done in partnership with a team of experts. We have reserved additional content (including a checklist of policy items) for businesses who are genuinely interested in working towards a best practice policy.
If you would like to read more about EncoreFX’s approach to writing a policy – you can click here. Once you enter your details, you will be emailed access to the full document and an EncoreFX representative will contact you to discuss what might work for you.
Creating a written FX hedging policy has many benefits, but there can be a lot to consider when developing or reviewing your own. Make it a priority to consider the four practical elements of a good FX policy; if you would like a review of your existing policy or think it’s time to put one in place, contact me today.
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