Articles

The 10 most common pitfalls of risk management

By Erin Harding June 25th, 2019

Pitfalls of risk management

Clients often come to us after falling into the same pitfalls when attempting to manage their foreign exchange risk.

Unfortunately, over the years we have seen that the same mistakes are made across all sectors, with both large and small businesses, and they often lead to costly consequences. In this article, we’ll highlight the pitfalls that are all too common, and explain how we can help you to avoid them.

1. Not knowing the extent of your FX exposure

Early in the process, your Account Manager will talk you through the factors that can affect the currency markets, in order for you to get a better understanding of your company’s exposure levels. It is important to do this before taking any further steps. Neglecting to account for volatile currency movements can lead to disastrous consequences.

2. Allowing a market view to influence or drive strategic decisions

Given how volatile the currency markets can be from one day to the next, using this view to drive important strategic decisions can be risky at best. Our experts can put a reliable strategy in place, enabling you to make informed decisions that offer certainty.

3. Not working to a structured risk management policy

Set up a strategy that aligns its KPIs to your business goals. This will give your policy a clear direction.

4. Unclear, or non-existent risk management objectives

If you have clear objectives, you can align these to your business goals and easily measure the performance of your strategy.

5. Focussing on the rate, and not the risk to P&L

It’s tempting to let the rates drive your decisions, but the potential risks to your business should be at the forefront of your strategy. We can advise you on how best to implement a bespoke hedging strategy for your company, based on market research and analysis. We follow a thorough, four step process to ensure that your strategy is correctly implemented, monitored and refined.

6. Use of overly-complex derivatives which present risks and give rise to earnings volatility

When managing risk, it’s a good idea to keep things simple. The simpler the hedge, the easier it will be to revalue, which is key to knowing your overall position and assessing your risk. Reliable valuations through the year will also avoid nasty surprises at year end. We can ensure that your strategy is monitored and maintained.

7. Not factoring the cash-flow implications

It’s all good and well to forecast a year ahead, if you can, by looking at order-books and sales forecasts. However, everyone knows that the oil in the engine of a business is cash. Access to ‘liquidity’, therefore, is something that should always be taken into account as just one factor in your overall hedging policy. Running out of available cash could force you to make bad decisions when hedging.

8. Overlooking group/internal risk mitigation opportunities

It is always important to consider the different ways in which your risk can be reduced naturally. Often there are ways to offset risk by matching suppliers and sales in the same country, or to ask suppliers to pay you in your own currency. Matching the cycles of your payments and receipts is also a good way to avoid risk.

9. Not considering the reporting of derivatives and potential volatility in P&L

Using derivatives is not always as straightforward as it appears. Sometimes the derivative will have to be accounted for separately, even being split up into different parts – ‘time value’ and ‘intrinsic value’. This can actually lead to more, rather than less, P&L as the derivative shows up in different sections of the accounts, sometimes even in different years, to the exposure being hedged.

10. Failure to understand all hedging solutions at your disposal

Once your Account Manager has fully understood the requirements of your company and you have created a risk management strategy together, you can then learn about all of the hedging solutions available to you. It’s best to give yourself a thorough understanding of every option, in order to hedge effectively.

 

Adoption of Smart’s Budget, Risk, and Solution framework will ensure that you focus on the most pertinent aspects of your company’s risk management processes; aligning hedging KPIs to company objectives.

To discuss our B.R.S approach and risk management strategies further, please contact your Account Manager on 020 7898 0500.