Since the value chain of companies of all sizes today is linked and intertwined globally, there are diverse opportunities in various markets for purchasing, development or selling products and services. A fundamental, age-old issue is the question of what value a good or service has in an economic area other than that in which it is produced. This conversion is referred to in general as the exchange rate. This is expressed and measured in the value of one currency relative to another today. In most cases, it fluctuates freely and is determined by supply and demand on financial markets. This makes currency risk a part of a company’s financial risk. This is because the exchange rate under some circumstances dictates a major part of the financial success of a product or service measured in terms of the profits. Another part of financial risk management is the risk of a change in interest rates. For the most part, this plays a role in financing when it is necessary to decide on a fixed interest rate for a period or an adjustable interest rate. It can also be relevant for the investment of cash in an environment of falling interest rates to ensure the highest possible interest income over the long term.
The third component of financial risk management consists of the risk of a change in the price of raw materials. It is also possible to hedge margins and earnings here by using available hedging instruments.
Support for Financial Risk Management
Financial risk management is to be regarded as a component of overall corporate risk, which may also represent, depending on the business model, the largest part of overall corporate risk under some circumstances. The significant importance of this in the corporate arena can also be seen in the German Control and Transparency Act (Kontroll- und Transparenzgesetz, or “KonTraG”) which states: “The Executive Board must adopt suitable measures and in particular, set up a monitoring system, so that developments jeopardizing the continued existence of a company are identified at an early stage.” Corporations – irrespective of whether or not they are listed on an exchange – are therefore obligated to introduce a system that makes business risks transparent, controllable and manageable. How can this be done?
1. Creating a foundation
This involves determining the actual current risk resulting from existing supplier/service agreements and customer relationships as well as an overview of liquidity in foreign currencies. Coupled with interest rate risk and the review of financing and financial investment agreements, this risk from supplier/service agreements usually revolves arounds the body of existing supplier agreements in the area of raw materials or commodity price risk.
The second step is to achieve transparency with regard to future risk in the three risk types. It is necessary not only to document the ACTUAL situation, but to include the TARGET components such as planned risk in a certain period, for example, within a fiscal year. This process, the determination of exposure, is rounded out with the netting of opposing positions such as the buying and selling of EUR/USD within a time period so that the NET risk position is calculated.
3. Risk Management
In the third phase, it is necessary to define the risk management strategy (hedging component, hedging instruments, terms, etc.) that should be documented in a guideline and its implementation. A critical factor here is compliance with the segregation of duties such as trading, controlling, confirmation and settlement, the use of trading systems to document financial transactions or the integration of online trading platforms.
We accompany you every step of the way through the entire risk management process. Whether you have a major project such as the construction of a power plant, series business in the automotive industry or product business such as fast moving consumer goods, we can provide our experience gained from almost two decades in international business and different industries. Our support services include:
- Determining risk exposure
- Calculating risk-bearing capacity
- Rules and guidelines
- Development of strategies for hedging risks
- Content support when concluding a contract and when negotiating with banks on derivative trading
- Design of development and process organization for derivative trading
- Support, also in an interim capacity, for trading hedging instruments
- Implementation of regulatory requirements such as EMIR, Dodd-Frank Act, Mifid, etc.