Making Hedge Program Analytics Actionable
On a purely theoretical level, the goal of a balance sheet hedge program is to simply cancel out the effects of FX volatility on the books.
If an exposure produces a loss, the theory goes, a derivative should produce an equivalent gain – offsetting the loss completely, and creating a net gain or loss of zero.
Unfortunately, that’s just theory. Reality is, there’s no such thing as a balance sheet hedge program that results in zero FX gain/loss. There are simply too many variables in play for this to be a realistic result.
Fortunately, there exist best-in-class analytics tools that make it easy for Treasury to get to the root of the inevitable FX gain/loss noise and provide straightforward explanations to management and other stakeholders. By isolating seven distinct sources of FX gain/loss and providing detailed information on each, applications like RTZ give users information that would (at best) take hours to gather, or (at worst) be inaccessible entirely.
That the data is available, however, is only the tip of the iceberg. The real value of hedge program analytics tools is the actionable nature of the data they provide. Quantifying why the FX gain/loss line isn’t zero is wonderful; insights that lead to fundamental improvements in the hedge program itself are even better.
A corporate could, for instance, identify large variances due to being consistently over- or under-hedged. Analytics platforms can help identify notional differences and the currency pair (or pairs) affected. This information allows Treasury to go even deeper into the variance by finding the exact drivers of the fluctuation they’re seeing and improve their program by hedging closer to the correct notional values.
Likewise, a company with a large unexplained FX variance in a single entity could examine underlying accounting to make sure individual transactions that drive exposures are being accounted for properly and the exposures themselves are being captured in reporting. They could, for instance, confirm the rate at which the transaction was recorded; are reversing entries happening at historic rather than current rates? Have general ledger account numbers been appropriately identified to be remeasured? Are accounts being remeasured that shouldn’t be?
“Shadow” or “phantom” balances – when a transaction is recorded in one currency but is settled in another, and the ERP system continues to account for the transaction in the original currency – can also be identified and rectified using hedge program analytics tools.
It’s not just about notional differences, either. Timing – particularly the rate at which a company is entering into derivatives, and whether it matches the rate at which transactions are being recorded – is critical, as well. Information provided by analytics tools can be used to adjust the hedge execution processes.
So remember: Your balance sheet hedge program will never perfectly eliminate FX gain/loss. But it is possible to know why – and better yet, to use that information to improve future hedge program performance and efficiency.
If you are interested in Reconcile to Zero or need help, our team of FX hedging consultants is always happy to lend a hand. Contact us today, or call 408-350-8580.