Trésorier/Treasurer magazine - N°90 - July/Aug/Sep 2015 - (Page 57)

The Risk Observatory by Hugues Pirotte (FinMetrics) Hugues Pirotte The key challenge of communication in hedging Much of the original difficulty that some of our clients face comes from the right definition of objectives for the risk management programme, the confusion around its goals and their link with the P&L of the company. And this materialises in the discussion of why we should use financial derivatives at some point. We, professionals of risk management, know that managing risks is accepting some costs against more stability of cash flows, which can ultimately increase the value of the firm. But, as René Stulz from Ohio University points it out again recently in 2013: "the main source of the confusion is that while the costs of risk management are usually explicit and readily identified, the benefits are less obvious and difficult to quantify". In a well-designed hedging strategy, bearing derivative losses when the exposure hedged turns out to be favorable to the firm, is normal and expected. Every year, we all buy car insurance. We don't need actually a car accident to justify our hedging strategy. We will simply compare all the insurance premiums to be paid vs. the potential financial outcome of an accident instead. In conclusion, the case for hedging has nothing to do with the actual result of the exposure. But I don't have to convince you of that. How do we convince others yet? The nature of losses In case of natural disasters for example, we bear actual losses, but also the present value of all future business opportunities lost because of business disruption, ultimately resulting in financial distress or bankruptcy. That is why insuring industrial premises is not put into question. This is particularly visible for risks with extreme consequences even though their probability of occurrence is very low. When it comes to financial risks, we also face potential disruptions, that sometimes might lead ultimately to financial distress, but not necessarily, and thus it seems à priori less obvious to show the benefits of a financial risk management programme. Beware that the sole reduction of volatility of cash flows is not an issue for hedging unless the previous can happen, i.e. disrupting the business or making it more difficult to manage and sustain with shareholder value repercussions. Otherwise, the shareholder herself could take hedging positions aside of his/her own investment in your firm. The idea is to LE MAGAZINE DU TRESORIER / TREASURER MAGAZINE - N°90 - JULY As we repeatedly said in previous articles, the modern version of the corporate treasurer post-2011 is of a very versatile kind. This time, we will focus on his/her communication skills. In face of all the regulatory developments, hedge accounting requirements, low or negative interest rates, low oil prices, volatile credit spreads, volatile currency basis, and budgetary issues such as up-front fees of optional products not perceived equally as future P&L profiles of forwards and consorts, the corporate treasurer must not only master them, find out the optimal path, but he/she must be able to prove the added value of those hedging operations to the top management. Intuitively, we know that an effective risk management programme provides added shareholder value, but, how can we sustain it? Some corporate treasurers face very strong questions on why are they hedging in light of the current market context, and it sometimes goes back to old-dated arguments like "you should know when to hedge and when not to hedge", which actually sounds like speculation rather than a risk management programme. But how can we persuade our board members of this statement? / AUG / SEP 2015 To Hedge or Not to Hedge, that's the... 57

Table of Contents for the Digital Edition of Trésorier/Treasurer magazine - N°90 - July/Aug/Sep 2015

Cover
Table of contents
EDITORIAL
FINANCIAL HIGHLIGHTS Luxembourg Tax News
INTERVIEW DataLog Finance
FOCUS
What do financial leaders around the world earn?
BIG DATA in treasury
Credit rating agencies in the line of fire?
FORUM
Hedge accounting: New standard, new challenges
Cyber Risk: Can Insurance be an Answer?
When FX Volatility hits your Corporate Earnings - How
Best to Manage your Currency Risk
Repo cash management - how it works in practice
20 ans de AXA IM, l’histoire continue
CORPORATE FINANCE
Time for more sophisticated corporate investment strategies
VAT electronic audit file: not too late to act, but no more time to lose
Focus sur l’actionnariat salarié
Struggling with cash forecasting? You are not alone
Coupling Delegation of Authority (DOA) with Bank Account Maagement (BAM)
15 MINUTES AVEC INTL FCStone
THE RISK OBSERVATORY
NEWS
LIFE BEYOND NUMBERS

Trésorier/Treasurer magazine - N°90 - July/Aug/Sep 2015