Smart Strategy: Restructuring FX Trades To Slash Hedging Costs

# Foreign Exchange

# Technology

Chatham helped FMC benefit from centralized trading while preserving management reporting and local incentives.

The treasury team at agricultural chemical producer FMC Corp. slashed monthly FX hedging costs by 40% by partnering with Chatham Financial to develop a multicurrency netting approach that allows them—and now other multinational corporations—to manage balance sheet risk more efficiently. Members of NeuGroup for Mega-Cap Assistant Treasurers heard the details during a session at the group’s first-half meeting sponsored by Chatham.

The new feature in ChathamDirect is “more than just centralized execution with automated back-to-back trades and accounting; it allows you to net different currency pairs into more liquid pairs, thereby maximizing economic offsets,” said Mike Burns , director of corporate treasury at FMC, who spoke at the meeting.

Beyond reducing the cost of hedging, the ChathamDirect solution has enabled a fourfold increase in exposure tracking while simultaneously cutting the time FMC spent in its treasury management system at month-end by 50%—all while automating workflows that had previously required extensive human intervention.

From exposure management to trade execution to accounting, “the automated end-to-end workflow combined with the multicurrency netting is a feature we couldn’t find anywhere else in the market,” Mr. Burns said. “It creates significant savings for the user; I think it will be a game changer for companies.”

Maintaining the strategy but changing the tactics. Mr. Burns explained why FMC’s approach to hedging and structuring trades had to change as the company’s geographic footprint and revenues expanded. The old approach of hedging “anything that moves” would not scale, he said.

Over a 10-year period of extensive M&A activity, FMC’s overall hedging objectives remained unchanged. But the size and structure of the company and the legacy hedging tactics had introduced significant incremental costs.

One example: Mr. Burns learned that following an acquisition and the subsequent shift in financial flows through a new overseas subsidiary, FMC was now over 15% of the global market on a single currency pair, resulting in higher trading expenses.

While business needs changed rapidly, FMC’s technology hadn’t evolved quickly enough. The addition of an ERP-bolt-on system for exposure management, trading and accounting only added “drag to the process,” he said. “My team would spend 80% of the time just operating the system and the remaining 20% of the time building reports in Excel that the system should have been producing.”

Shifting from merely operating to proactively adding value required a technology change, but it couldn’t disrupt how other functions received information about derivatives. “I needed a way to make the changes to our execution in the markets, while improving operational processes, without any changes to accounting, tax or FP&A workflows,” he explained.

Avoiding a one-off solution while tailoring the RFP process. Mr. Burns said FMC spent about 20 hours per vendor in demos to ensure its requirements were clearly understood by the vendor implementation team, and to make sure the FMC team understood the platform’s capabilities and constraints. “We wanted to make sure that everyone knew what they were actually biting off,” he said.

“We were looking for a partner, because after seeing the various systems we knew some incremental design was going to be required with whomever we chose,” he added, emphasizing that the solution couldn’t just be tailored to FMC’s specific requirements. “Our treasury tech ecosystem is a hub-and-spoke model, but I don’t want to be the only company in a vendor’s client base using their tool a certain way” as it creates scaling risk both for the vendor and for FMC.

The hours FMC spent with Chatham’s team helped build trust. “Any incremental development by a technology vendor requires a degree of trust,” he said. “If a different company had come to us and pitched the same idea, I think it would have been a bigger leap of faith within the organization. Knowing the team and their capabilities got us over that hurdle.”

A centralized view with decentralized results. Chatham describes the innovation as a hedge “flattening” system in which the parent company executes the minimum number of trades while ensuring only USD-facing pairs are shown to the banks (see chart). The external, flattened hedging transactions are therefore the most liquid pairs available, such as EUR-USD, USD-DKK and USD-TRY, Mr. Burns said.

He added, “The other piece that’s attractive is you can get material offsetting; if I’m long euro against Aussie and I’m short euro against Swiss franc and trade those two pairs separately, I get no euro offset. But when you break it all down into a single EUR trade, a single AUD trade and a single CHF trade, now you get that economic offset with EUR without any change to AUD or CHF.”

Equally if not more important is the system’s ability to create the required internal trades without having to trade that exact currency pair with a bank. For example, a Danish (DKK) subsidiary with Turkish (TRY) exposure would require a TRY-DKK hedge—a highly illiquid pair. Instead, “the system creates an internal TRY-DKK trade even though I’m only trading USD-TRY and USD-DKK,” he said.

Recording subsidiary-level results and accounting was critical. “We wanted the local teams responsible for the FX results within their local financials, so the derivatives needed to be recorded at the subsidiary level; but we did not want to be taking illiquid currency pairs to the banks,” he said.

“So, ChathamDirect takes 400 exposures, builds 40 bank-facing trades but then takes those bank trades and reverse engineers 400 subsidiary-facing trades and pushes them down to the local entities.”

Beyond FMC. Chatham in an email told NeuGroup Insights that since the launch of the functionality developed with FMC, “a handful of additional large multinational corporates” have taken advantage of the hedge flattening technology.

“We expect this number to grow as many multinationals reevaluate their approach to determine if they can benefit from this new standard in foreign currency netting.”