Commercial Clients: Don't Forget to Hedge Against Foreign Exchange Risk
24 hours a day: foreign markets are at work and companies face risk.
"When you take a look at the foreign exchange markets – and they are on a 24-hour basis the way they move around – there is risk that companies, or CFOs of companies, face 24 hours a day," said Don Lloyd, Senior Vice President and Manager of Capital Markets – Foreign Exchange, Rate Swaps and Commodity Derivatives at Associated Bank.
Just like it's a good idea for individuals to hedge and manage their risk, to show caution with their financial endeavors, so too should companies. Since the majority of American companies have a toe in international business, they should be paying attention to world markets: foreign exchange rates, interest rates and commodities. Lloyd is on the front lines monitoring the day-to-day changes in these markets, to offer guidance.
A large percentage of U.S. manufacturers have an international component to their business.
"Let's just take a look at our customer base – typical customer base – at Associated Bank," Lloyd said. "These are mostly clients, corporations, companies that are manufacturing. So they source their goods and services from overseas a lot of times. In fact, studies have shown that of companies coast to coast in the U.S., … (a large percentage) will do some sort of international business, whether they're sourcing goods and services from overseas or whether they're selling goods and services overseas."
And, of those selling or sourcing internationally that are subject to that foreign exchange exposure, Lloyd notes that a large portion are not doing any hedging. This is where Lloyd and his team step in and offers their insights.
"They have this exposure that exists, but they do absolutely nothing about it," Lloyd said. "They either don't know … (or) have prioritized it too low, but it's a risk that could be mitigated and it could be closed down, if they just take the time to learn a little bit about what hedging is all about."
Lloyd and his team monitor the ebbs and flows of the markets interacting with one another around the globe, and they share with their clients their advice based on these global interactions.
How do they do that? By monitoring foreign exchange rates, interest rates and commodities.
"… The foreign exchange markets, there are 150, 200 different currencies in the world," Lloyd said. "The majors, if you will – our major trading partners – whether that's Canada, the European zone – which is the Euro – Japan, Mexican Peso, those are the major currencies that a lot of North American companies have exposure to. So we want to focus on those first."
And although the markets are fluid and can change wildly at times, Lloyd's day typically unfolds the same way by checking foreign exchange rates. Then come the interest rate and commodities updates.
"I want to find what the ranges are throughout the day," Lloyd said. "I want to find out if there have been economic releases in … (foreign) countries or what was talked about in upcoming releases. I want to find out what the drivers are in the market. That pretty much sets the stage for how this big pool of money that's known as this hot money – this investment money – sloshes around the world and will move like an amoeba from one country to another looking for some return, given some amount of risk, and as those parameters change, that money moves; that's the hot money."
"On the interest rate side, interest rates are nothing more than the cost of money, whether you're a borrower or lender," Lloyd said. "So we have to sit there and address those people, and … the term structure of interest rates, the yield curb, if you will."
"When it comes to the commodities side, oil and natural gas, likewise, like the price of gold, like the price of stocks, there is market risk," Lloyd said. "These prices move all the time. What we try to do is be the eyes to the market for CFOs and companies that are out there making bicycles or making whatever they're making. They have this risk, (and) they can't spend all of their time looking at that risk. Let us be the eyes to the market."
So important are these foreign markets to the operations of many American businesses, Lloyd said. Yet, for some reason, companies aren't paying near enough attention to them, he notes. Lloyd therefore works to show them the risks they face, and he helps develop a plan to hedge against those risks.
Corporations and individuals alike aren't paying close attention, largely because of how easy it is to view the U.S. dollar as the only currency that matters, Lloyd notes.
"That is one of the challenges that we have," Lloyd said. "The U.S. is very dollar-centric, and historically there's reasons for that. As we came out of WWII, the U.S. was pretty much the only game around, globally, so we became the bank of the world, we lent money to the world, and everything was based in U.S. dollars. Fast forward to today, the U.S. is still very dollar-centric.
"(Here in the United States), we don't think in terms of exchange rates, we don't think in terms of 'what is a dollar versus a Canadian dollar, a dollar versus a Euro dollar.' If you're in Canada or if you're in Europe, you grew up with that, you know what exchange rates are, you know what exchange rate risk is. So therefore in the US, you deal with companies that will price goods and services overseas in dollars, and they think they have no foreign exchange risk, when in fact they do."
"So it becomes an education process," Lloyd said. "And like any education process it's not a 30-second line, it is something you have to sit down, think through and then remember and (think about) where to apply it. So let's learn the concepts, let's learn the terminology and then let's apply those concepts and terminology."
Lloyd and his team work hard to educate their customers about the pitfalls of turning a blind eye to world markets and, in turn, to come up with an appropriate plan of action.
"That's what my job is, and that's my team's job to basically take a look at interest rates, commodity derivatives, foreign exchange risks that companies face, educate them if needed, or give them the services and the product, if you will, to help mitigate and reduce those risks," Lloyd said.