As seen on Treasury & Risk
In many ways, it’s the final hurdle in the process of establishing a foreign currency hedge program:
After treasury has decided to take action to mitigate risk caused by foreign exchange (FX) fluctuations, after exposures have been identified and quantified, after a strategy recommendation has been formulated, and after relevant partners and technology have been queued up, the last step is gaining approval for the program from the board of directors or a committee designated by the board.
By the time you are ready to present your FX hedging strategy recommendation to the board or board-appointed committee, the wheels will have been in motion for some time. The treasury team will have scrutinized an array of strategies and will have selected the best one for their circumstances. But that doesn’t mean the board (or committee) will automatically approve the proposal.
If your company has recently experienced significant impacts to its earnings caused by FX volatility, there’s a good chance you will leave the board meeting with the authority to move forward. Nevertheless, you need to come prepared. Here’s what that means.
1. Put together a solid proposal
Prior to your presentation, decision-makers need to receive copies of the proposed policy, including its objectives, strategies, limits, controls, and authorizations. You’ll want to be sure to include:
- A historical analysis of the impact of FX risk on the company, containing at least a three-year trend;
- Some detail on the “before” and “after” of the proposed policy;
- Discussion of any alternatives that were considered; and
- An analysis of what the competition is doing.
If it’s the first time a hedge program has been presented to the board, or if the issue has not been addressed in several years, it’s safe to assume the board knows relatively little about hedging. Thus, it’s important to present information in digestible chunks; treat your core proposal almost as an executive summary, with more detailed information attached as appendices.
2. Have one or more executives lobby for the hedge program prior to your presentation
An executive sponsor will likely prime members of the group. Ideally, this sponsor should come from the C-suite, though it could theoretically be the head of operations. He or she should be expected to have high-level conversations with board members about their risk management philosophy, including what is off-limits, and relay that information back to treasury.
Additionally, the sponsor should provide information about logistics of the board meeting itself. Are there any special requirements? Will treasury personnel present, or just be available for questions? Which board members are most likely to have doubts or concerns? Which, if any, of the board members have experience with hedging? The more prepared treasury is, the better.
3. Keep your presentation at a high level
When treasury professionals present their hedge proposals for board (or committee) approval, they may find it’s easy to dive into the weeds when technical issues come up. That’s a natural consequence of having a high level of expertise. However, it’s worth remembering that most board or audit committee members are not treasury experts; they need somewhat broader strokes.
Keep your presentation focused on the risks and hedge objectives: Explain how much volatility the company can expect to face, how that volatility can be expected to impact the company’s financial statements, and how treasury can use FX hedging to protect the balance sheet and/or margins. Focus on strategies more than tactics; summarize risk at a high level. Speak to currency risk categories, exposure magnitude, and direction—don’t go as detailed as providing a P&L by currency. The deep-dive details, statistics, and charts that may have sold the program’s usefulness within the treasury function should be included in the board presentation only as appendices and supplementary handouts. The presentation itself should be clear, concise, and benefits-focused.
4. Provide actionable alternatives
Utilizing derivative instruments like forwards and options is a highly effective, time-tested way to mitigate FX risk—but it’s only one way to do so. Companies can also reduce the potential effects of currency volatility through operational changes. They can structure customer or vendor contracts to reduce risk. They can start sourcing from new regions. They can deploy new tax structures. The ideal solution is never the same from business to business, but before recommending currency derivatives, a treasury team needs to explore all the company’s possibilities.
Your board of directors will want to see that treasury has done all the appropriate legwork. Your presentation should include a brief synopsis of your analysis of the company’s various alternatives for mitigating FX risk. Then it should describe why your recommended approach is the most cost-efficient and effective method (or blend of methods) to accomplish your objective.
5. Arrive with a resolution in hand
It is crucial to come to the board or committee presentation with a resolution in hand. The resolution should be vetted through legal and the executive sponsor before the board presentation, and should, in particular, include any Dodd-Frank language that the legal team identifies as necessary. Failing to get buy-in from all interested internal parties before presenting the resolution to the board could cause delays in implementation of the hedge program—delays that might unnecessarily increase FX risk by extending the time it takes to get the program up and running.
6. Be prepared to answer common questions
We’ve seen many treasurers present FX hedging proposals to the board for final approval, and have found board or committee members across industries typically ask similar questions. You should walk into the meeting expecting to hear some variation of:
- What currencies are we talking about, and what have they been doing lately?
- What are the magnitude and direction of our FX exposure?
- What are our competitors doing to address FX risk?
- Have the auditors reviewed the plan?
- What is a hedge program going to cost?
Fortunately, the answers to most of these questions are fairly straightforward. Every treasury team presenting a hedge program to the board should be intimately aware of which currencies are likely to drive volatility in their organization’s financial statements, both above and below the line. Be prepared, and make sure that your numbers align with other forecasts and financial data that the board has seen, specifically international revenue and expense data when the hedging program will involve anticipated transactions. Rarely is the treasurer called on to share the numbers in one of these presentations, but when it happens, having inconsistent or insufficient quantitative information will raise doubts about your preparedness to execute the program.
It’s also common for the board—or, frequently, one individual on the board—to want to understand whether the company is in a long position (with more revenues than expenses) or a short position (with more expenses than revenues) for a particular currency. The answer may lead to questions about whether now is “the right time” to hedge. Responding to these questions is a delicate matter. The treasurer should reiterate his or her team’s intent to put in place a program with process controls and limits to meet the defined objective, and let board or committee members know that the first hedges will be executed in alignment with those processes.
Identifying the FX risk-mitigation actions of an organization’s competitors can also be challenging. If the competitor is publicly traded, and the hedge program is appropriately disclosed, then treasury may be able to glean important details from footnotes in the company’s SEC filings. However, if the competitor is private, there may be no SEC filings. And if it is a small part of a larger conglomerate, then filings may not report activities specific to the competitive group with enough precision to be useful to the discussion. In fact, board members themselves may have useful insights into what’s happening with the competition as a result of their own networking relationships. Be sure to work with your executive sponsor to ensure such information is relayed to treasury prior to the meeting.
Auditors should have been engaged in the discovery process, so by the time of the board presentation, they should be ready to assure the board that the company has appropriately contemplated the hedge accounting requirements. Auditor interpretations of FASB guidance vary slightly, so treasury needs to make sure to understand their auditors’ requirements. If the board can see that you are appropriately educated and prepared, their confidence in the program will increase.
Finally, many board members are concerned about the “costs” of hedging, so this is a question that will inevitably be raised during the presentation. You need to be prepared to discuss costs to the company of bank “profit,” forward points, and option premiums, as well as overhead for the hedge program (accounting, trading, technology, etc.). This question is easier to answer if you understand which costs your board members are concerned about.
This is also a good time to educate the board on getting what they pay for. If they prefer to ensure results (using option strategies) rather than lock in results at current rates (using forward strategies), then the company will have to pay an insurance premium. In fact, in talking about the option programs, it is better to use insurance language over trading language. Insurance concepts should be easy for board members to grasp, and FX options used in hedging have a similar profile as an insurance policy.
Additionally, performance reporting for cash flow hedges should focus on FX rates delivered into the consolidated financials, and reporting for balance sheet hedges should focus on mitigation of FX gains/losses—never on the amount of derivative gains/losses. The amounts will never be consistent, nor will hedging always net gains; however, hedging can deliver on the program’s objectives.
Putting It All Together
When it comes to gaining final approval from the board of directors to implement a foreign currency hedge program, the bottom line for treasury is this: Be prepared.
Your confidence in your program, and your preparation for the presentation, will inform the board about the company’s readiness to embark on FX hedging. The board (or committee) review is the final “go” or “no go” on a project, the preparation of which has likely already taken months.
Before walking into the presentation, make sure you know the answers to the questions they are likely to ask, keep your presentation strategy- and objective-focused, explore the alternatives for the board, and be ready with a resolution in hand. With board approval, you’ll be ready to start actively mitigating FX risk soon after you leave the boardroom.