Corporates are Hedging Less, Have FX Transparency Concerns: Survey

Although there has been recent media commentary on the growing importance of corporates to FX businesses, a new survey commissioned by FX platform MillTechFX finds that the level of UK corporate hedging has declined thanks to lower volatility.

The survey polled 252 senior treasury professionals as corporates in the UK, and found that, compared to 2022 when 89% of UK corporates hedged their FX risk; in 2023, this fell to 70%. Of those that don’t hedge, 67% are now considering doing so, compared to 89% in 2020. Despite 59% of respondents stating that their hedge ratios increased in the past year, the average hedge ratio dropped from 50-59% in 2022 to 40-49% in 2023.

Corporates in North America had a higher average hedge ratio of 50-59%. The higher hedge ratio seen amongst North American corporates compared to those in the UK may potentially be a reaction to the well-documented strong FX headwinds that North American firms experienced towards the end of 2022, MillTechFX observes. It adds that since exporters in North America may typically be more exposed to currency movements than importers, the higher hedge ratio suggests that many may have sought to lock in the gains created by a weaker US dollar in 2023 (the survey was conducted in August when the dollar had recently hit its 2023 low, it has since climbed to its highest level since November 2022).

Average hedge lengths dropped from five months in 2022 to four months in 2023, suggesting, MillTechFX says, firms are looking for flexibility to adapt to the changing market, rather than locking in a rate for a long time.

Even though there is widespread acceptance that volatility has dropped in recent times, CFOs and treasurers are still prioritising risk management, with 41% planning on increasing their hedge ratio, while 40% plan to increasing their hedge windows. “This suggests that CFOs are moving to hedge more of their FX risk to protect their bottom lines from currency movements,” the report states.

The survey also finds what MillTechFX says is a “transparency problem” in FX with 62% of respondents stating they believe a lack of transparency exists. The tried and tested argument of hidden costs in the spread is raised, although there seems to be a belief that trades should be done at mid. The report also uses the example of a corporate trading 30 points away from mid to highlight “hidden” costs (it does note it is not an “explicit” cost but remains just as much of a cost), although under the terms of the FX Global Code, the presence of mark-ups in the all-in price are meant to be disclosed by the LP.

The report also takes aim at “tailored pricing”, whereby the “best rates are reserved for institutions that transact the highest volumes meaning mid-sized corporates and asset managers are often neglected and struggle to get the best possible deal.”

Many large corporates may already have multiple sources for pricing, so the fact that larger firms find demonstrating best execution most challenging suggests that this encompasses factors beyond just having multiple counterparties

Of those firms that responded, 30 had just one counterparty relationship, while 160 respondents had two or three (80 each) and 46 had four. Just 13 UK corporates in the survey had five relationships and three had more than that.

MillTechFX says that firms with 500+ employees reported demonstrating best execution as their biggest challenge, and adds, “In our experience, many large corporates may already have multiple sources for pricing, so the fact that larger firms find demonstrating best execution most challenging suggests that best execution encompasses factors beyond just having multiple counterparties. These may include getting a transparent view of execution costs and performing counterparty due diligence, which corporates may find difficult due to time and cost constraints.”

The survey also found that 59% of respondents said that FX costs had risen in the past year, with 12% stating they had risen significantly. Just under 23% said their FX costs had decreased, while just under 30% said they were unchanged.

Although not as stark as the findings from a similar North American survey, UK corporates also say they are looking at counterparty risk more in the wake of the banking collapses earlier in 2023. Whereas 80% of North American corporates were looking at expanding their bank panel, 73% in the UK are looking at the issue. The report says that only 51% of UK corporates regularly monitor their FX counterparties’ credit ratings and applies what might be termed a hedge fund view of the issue by suggesting that corporates add significantly to their treasury function. “We believe that corporates should consider establishing a robust counterparty risk evaluation framework that considers a range of risk factors,” it states. “These include monitoring realised and unrealised profit and loss for each counterparty, credit rating from reputable rating agencies, credit default swaps as well as regular counterparty review and monitoring activities.”

Automation, inevitably, gets air time in the report; it found that 75% of senior finance decision-makers at UK corporates are looking into new technology or platforms to automate their FX operations. This is a slight drop from 89% in 2022 and 78% in North America, and MillTechFX suggests this may reflect more businesses beginning to implement technology into their FX operations over the past year. It does also note, however, that it may also be a sign that treasurers may have prioritised other areas such as servicing debt, deploying cash reserves in the most efficient manner and counterparty diversity over automation.

The top drivers for automation are cost savings (31%), eliminating silos (29%), operational risk reduction (28%), simplicity (25%) and efficiency gains/customer demand (24%). The top driver for treasurers was eliminating siloes. “This is unsurprising,” the report states. “As for treasurers, in particular, it is imperative than any new infrastructure can communicate with other treasury systems to streamline workflows and automate manual tasks. This in turn can help eliminate human error and create a more scalable treasury function.”

The rise in ESG as a key priority is more than just box-ticking. Stakeholders including shareholders, clients and employees are demanding progress in this critical area

The report also takes a look at ESG issues and how they relate to FX markets. It notes that driven by pressure from investors, governments and consumers, ESG criteria are now “central to the decision-making process” for many businesses. The report also observes that this trend has also begun to play an increasingly important role in FX, with 85% of respondents saying that ESG credentials affect their selected FX counterparties. It adds that 77% of larger corporates surveyed (250 employees+) said ESG has grown in importance in the past, compared to 69% of the smaller corporates, “perhaps showing larger firms are taking the lead on the ESG front”.

To help meet ESG criteria, the report recommends that corporates adopt the FX Global Code to highlight they have fulfilled the governance element of their ESG commitments. “Signing up to the code is therefore a key step for firms seeking to be a good corporate citizen and demonstrate their ESG credentials,” it states.

Corporates could also consider the ESG credentials of partners, it continues, adding it’s not just a company’s own infrastructure that reflects strong ESG credentials but also that of any partner or affiliate organisation. “When transacting in FX, we feel firms should seek to use FX providers which adhere to internationally recognised ESG standards, such as the Principles for Responsible Investment (PRI),” the report states.

“Despite the relative calming of currency volatility over the past six months, it is clear that senior finance decision-makers at corporates are still struggling when it comes to FX due to a lack of transparency,” argues Eric Huttman, CEO of MillTechFX. “FX costs are typically hidden in the spread and the best rates are reserved for institutions that transact the highest volumes.

“Corporates also tend to only work with a small number of banks for their FX hedging, he continues. “It can take months, even years, to set up banking relationships and our research shows the majority only work with three banks. This makes it harder for them to compare prices in the market because they have fewer access points. As the recent banking crisis demonstrated, reliance on a small pool of counterparties can be a serious risk.

Huttman further points out it is “positive” to see the finding that corporates are looking at expanding their counterparty panels, adding, “This is not only beneficial from a risk management perspective but has the added benefit of providing corporates with the ability to compare prices, aiding transparency and enabling best execution. Embracing digitisation can also help strengthen transparency, with most corporates now exploring new technology as they seek to cut costs, eliminate silos and enhance operational efficiency.”

On ESG, Huttman reveals that many of MillTechFX’ clients now ask about the firm’s own ESG practices, observing, “The rise in ESG as a key priority is more than just box-ticking. Stakeholders including shareholders, clients and employees are demanding progress in this critical area.”

Huttman concludes, “Looking ahead to the rest of 2023 and beyond, we would encourage corporates to gain a transparent view of their FX execution, expand beyond their traditional banking relationships in favour of tech-enabled solutions and implement a carefully thought-out risk management strategy to protect their bottom lines during these uncertain times.”