Hedging Policy Management
In an economic environment with a strengthening dollar, a weakening euro and yen, and a steady anticipation of interest rate hikes in the US, the topic of currency hedges comes closer to the spotlight particularly for multinational firms with presence in the US, Europe, and/or Asia. As a result, firms with greater currency risks that have not previously hedged currency may be evaluating whether now is a good time to start. As the experts in value management, value strategy, and value creation, we outline below two items of importance in implementing and managing a hedging policy.
The first item of importance is the clear allocation of decision rights across company hierarchical levels and functional areas to coordinate hedging activities and control exposure limits. The company should consider assigning decision rights for the size and horizon of hedge positions, instruments to use, and price parameters. Clearly and logically allocating responsibility for the implemented policy will make the system more transparent, as “owners” for each decision will be identified. This promotes stronger accountability for the decision makers in the hedging process.
Another related item of importance is the careful monitoring of the hedging policy’s results. The company should establish performance metrics that will help them evaluate whether the hedging policy is meeting its objectives. For example, some results that may indicate that the hedging policy may be working well include (1) a steady positive operating margin, (2) a stable cash flow, and/or (3) a reduction in exposure to foreign currency. These measures should be structured in a scorecard format so that the top management, board of directors, and shareholders can monitor hedging operations and evaluate how effectively they are supporting business strategy.
Overall, the two items of importance above will help the firm have a stronger internal governance system on its hedging strategy. The next article in this 2-part series will be the precursor to this article – it will focus on the key questions that firms should ask themselves when evaluating if hedging is right for them.