What Board Members Should Know About Hedging FX Risk
Minneapolis, MN | October 3, 2024 | By: John Trefethen, Director and Co-Founder
If a company is hedging, or considering hedging, foreign exchange (FX) risk, to provide proper guidance and authority board members should be aware of the following:
Objective of the Hedging Strategy. Board members should understand whether the hedging strategy is aimed at protecting cash flows, stabilizing earnings, or managing balance sheet exposures. It’s helpful for board members to know the company’s specific FX risks (transaction, translation or economic) and why the company has choosen to hedge them.
Types of Hedging Instruments. Board members should be familiar with the financial instruments used for hedging, such as forward contracts, options and swaps. Each instrument carries its own level or risk, cost, and complexity. Understanding which instruments the company uses helps assess their potential impact on liquidity and earnings.
Costs and Financial Impact. Hedging comes with costs, such as premiums, margin requirements and reporting costs. Board members should know the overall cost of the hedging program and how it affects financial performance, ensuring the benefits outweigh the costs.
Effectiveness of the Hedge. The company’s risk management team should regularly review whether the hedging strategy is mitigating the FX risks as intended. Board members should be made aware of any mismatches between the hedge and the underlying exposure, or if changes in market conditions have rendered the strategy less effective.
Accounting Considerations. FX hedging can involve electing hedge accounting under GAAP or IFRS. Board members should understand the benefits of electing hedge accounting for minimizing earnings volatility from the company’s hedging activity.
Having a board that is knowledgeable on these topics will help them to make informed decisions and provide the appropriate guidance for the company to effectively manage its FX exposures.
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Author: John Trefethen, Director and Co-Founder
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