Dealing with Volatility- Building an Effective Forex Strategy NASSCOM BPO Strategy Summit June 2009 Suresh C Senapaty Executive Director & CFO Wipro Limited
Contents Why FX Risk Mgmt Matters Anatomy of FX Risk Mgmt Key Aspects of FX Risk Mgmt 2
1. FX Volatility Is The Reality 3
2. Risks of Forex Volatility 1. Risk to rupee EPS for an exporter/importer listed in India 2. Risks to rupee costs for an exporter/importer listed abroad 3. Risks to net cash-flows for a Captive IT/BPO center of an MNC 4. Risks to budget for an India based R&D Center of a Global MNC 4
3. Specific to BPO Industry • Levers for profitability: ü Pricing ü Resource Management – No of resources & Per person cost ü Seat Utilization ü Attrition Mgmt ü Forex • 1% movement in Forex will have 0. 7% adverse/favorable impact on OM% • Average BPO industry margins at 12 -13% • Nearly 10% of Forex movement that happened in 2007 (Rs. 45 to 40), shaved off 7% margins from the business • Similarly, in 2008, 25% movement from Rs. 40 to 50 added 15 -16% margins back • Now, in May 2009, 6% movement from Rs. 50 to 47, again took away 4% margin. • Thus, significant impact of Forex on P&L. • Sharp rapid movements making it difficult to deliver consistent financial performance and build right business model. 5
4. Areas of Impact From Financials Perspective, impact on: ü Gross Revenues ü Net inflows ü EBIT/PAT (Gross Rupee Rev = F/C Revenue x current Exchange rate) (it can be argued economic impact restricted to the extent of net flow) (due to mismatch in currency of Revenues & currency of Expenses) ü Balance –sheet (Translation impact for F/C current assets & fixed assets) From Business Perspective: ü Committed orders with frozen pricing ü Committed orders with open pricing ü Run-rate certainty but not committed Zero hedging will mean Financial Results at spot & assets going through MTM every period-end 6
5. Objectives of Hedging Reported Performance Currency Movement Effective Hedging Revenues/ Profits Effective Hedging Constant Currency Operating Results Fx Volatility Timeline Primary Objective of Hedging is to deliver (a) Reduce the volatility in operating financial performance due to forex (b) Enhance the predictability of performance 7
6. Threats to Effective Hedging Underlying Exposure Timing Mismatch Volume Mismatch Hence the Directional Mismatch Objective of a Corporate Treasury is to Get these 3 Basic Parameters Right 8
7. Type of Forex Instruments 1. Forewards 2. Range-forwards 3. Puts 4. Strips 5. Swaps 9
8. Three Aspects of FX Risk Management Enabling Policy Treasury Objectives Robust Processes Aligned Accounting Treatment 10
8 A. Aligned Accounting Treatment – MTM Vs. Cashflow Illustrative Case – MTM vs. Cash Flow Hedge Forward Rate of 48 for Aug 2010, taken a hedge of $1 Mn monthly Sales. Business has Operating margin of 15% Example: Hedge for Cash-flow from Collection of Debtors (DSO: 60 days) Cash-flow Sept 15, 2009 Sept 30 Dec 31 Aug 2010 Forward at March 31 Aug 2010 Forward at 46. 50 MTM C/f Hedge Balance-sheet 43. 0 MTM Gain of Incr. MTM Gain Rs. of Rs. 1. 5 Mn MTM Gain of Rs. 1. 5 Mn 3. 5 Mn Cumulative MTM Gain Rs. 5 Mn 49. 0 Incr. MTM Loss of Rs. 6 Mn Cumulative MTM Loss Rs. 1 Mn June 30 Aug 2010 Forward at 51. 0 Incr. MTM Loss of Rs. 2 Mn Cumulative MTM Loss Rs. 3 Mn Aug 15, 2010 Spot at 48. 0 Incr. MTM Gain of Rs. 3 Mn Cumulative MTM Rs. 0 Mn 11
8 B. Enabling Policy Type of Exposures F/C Cashflows F/C Capital Asset / Liability F/C Monetary Asset Underlying Risks Economic Impact on Operating Performance Economic/ Pure Accounting Depending whether it will be ever paid/realized Pure Accounting MTM Shock to Income Statement Based on Period-End Exchange Rate Type of Hedges Designated Hedge Capital Hedge 12
8 C. Robust Processes Policy Control • Defined Risk Mgmt Framework & Documentation flow • Audit committee oversight of Treasury Policy • Clear limits for quantum of hedges under each category Independent Controllership Fn Optimal Information Flow • Independent Back-office • Robust system as backbone • Confirmation & Settlement function under controllership • Daily and weekly MIS on positions through Independent Middle office • Documentation for hedging signed-off jointly by Controller & Treasurer • Reporting to Business Mgmt and Audit committee • Audits at defined interval of policy & process adherence • Constant benchmarking for best practices and against changing business needs Thank You 13
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