Digital hedging - what is it and how is it used?

With global uncertainty and currency volatility, foreign exchange risk is a priority for businesses. Companies are faced with the need to hedge currency risk in order to maintain the stability of their financial operations. Digitisation of the international payments chain becomes inevitable as transaction volumes increase and risk management becomes more complex. The use of advanced digital solutions can not only simplify the hedging process, but also guarantee predictable cash flows.

Digitising currency hedging

Hedging is a financial strategy designed to reduce or eliminate the risks associated with adverse movements in market prices or exchange rates. It generally involves entering into transactions that offset potential losses on other assets. In the context of foreign exchange risk, hedging may involve the use of instruments such as forward contracts, options or swaps to fix the current exchange rate and avoid losses arising from future fluctuations.

Companies are exposed to exchange rate risk in many ways: when they evaluate exports and imports paid for in foreign currencies, when they assess their relative competitiveness on the world market and when they make financial investments outside the euro zone. This is why hedging currency risk is an important task for any company that, in one way or another, wishes to participate in the globalisation of the economy. Hedging currency risk is based on two key elements: the ability to know in real time the nature of the risks (amount, base currency, maturity) and the ability to activate the most appropriate hedging procedure for each transaction.

The practical complexity of managing foreign exchange risk increases in proportion to the volume of transactions at risk. Digitisation of the international payments chain quickly becomes a necessity when the risk becomes significant and prolonged:

• Because of the critical nature of foreign exchange risk;
• Due to the complexity of the hedging process.

Reliable and predictable cash flow is a prerequisite for peace of mind in corporate governance, particularly in times of uncertainty and volatility in markets and prices.

Currency risk

Currency risk is a serious threat to your company's accounts. It arises whenever a company interacts with counterparties using foreign currencies, and is particularly high in times of economic instability. When it comes to anticipating and mitigating risk, the corporate treasurer is responsible for managing the five main types of threat:

• Currency risk, linked to changes in exchange rates ;
• Interest rate risk, linked to changes in financing costs;
• Fraud risk, linked to cybercrime;
• Customer risk, linked to debt recovery;
• Сommodity risk, resulting from price volatility.

Currency risk arises when a sale or purchase transaction is based on a counterparty in a foreign currency, i.e. denominated in a currency other than the euro. Examples include the purchase of raw materials for payment in dollars or the sale of a service for payment in pounds sterling. The risk also exists when payment is deferred: an order is placed today, delivery takes place 6 months later and all or part of the payment is due on receipt. During this period, the relevant exchange rates may change, and the actual equivalent value in euros of a purchase or sale may vary proportionately, either upwards or downwards.

Currency risk therefore directly threatens the real value of cash received on sales and purchases of goods and services outside the eurozone. The treasurer must minimise unforeseen currency fluctuations in order to ensure the accuracy of cash flow forecasts and the stability of the company's investments. Geopolitical tensions and economic difficulties can increase currency volatility, which in turn increases currency risk. This risk affects not only commercial activities, but also the company's financial operations, such as the value of bank balances and credit conditions.

Currency risk: The complexity of hedging

The basic principle of eliminating currency risk is to hedge the risk in exchange for remuneration:

• The parallel conclusion of a forward exchange contract based on a symmetrical perspective (the gain or loss on the commercial contract is offset by the gain or loss on the exchange contract). This is known as a currency swap;
• Guarantee the value of the counterparty by means of insurance;
• Include various clauses and mechanisms in the commercial contract to spread the risk between the seller and the buyer, which can go as far as contractually fixing the exchange value to lock in the counterparty.

For an organisation involved in international trade, the exchange rate risk is assessed globally, period by period and currency by currency. Any losses due to unfavourable exchange rate fluctuations are offset by gains from transactions in the opposite direction over the same period and in the same currency. Currency risk control is therefore based on an assessment of the potential difference expected for each period.

Managing currency risk, like all other risks, requires teamwork and close cooperation between the sources of risk (for example, the sales or purchasing departments) and the finance function. The decision as to whether and to what extent to hedge the risk depends on the risk management policy and is determined by economic factors such as the geopolitical situation. The ability to take into account all the risk factors associated with a particular transaction is the key to successful foreign exchange risk management.

Digital foreign exchange risk management: Benefits and challenges

Comprehensive foreign exchange risk management relies on a multi-user information system capable of circulating heterogeneous data rapidly and implementing complex financial protocols without delay. It is particularly important that such a system allows for the simultaneous management of a large number of transactions, which is essential in an active international trading environment. As the number of transactions buying and selling currencies increases, and as currency volatility rises, managing foreign exchange risk becomes increasingly complex and presents many practical challenges.

These include detecting and determining the nature of the risk as soon as it arises, assessing its prospects as part of the company's overall foreign exchange risk management, deciding whether hedging is necessary and selecting the appropriate instruments. Monitoring the costs incurred in hedging operations is also becoming an important part of this process. This is why the use of a digital solution to hedge foreign exchange risk is becoming more and more feasible as risks and transaction volumes increase.

Digital Hedging: Conclusion

In conclusion, digital foreign exchange risk management offers significant benefits. Simplifying the hedging process speeds up information sharing and unification of decision-making, which reduces uncertainty for the business. The most tangible effect of digitisation is achieved when it covers the entire payment chain, including cash management and banking automation. The best solution for effective enterprise risk management is to use advanced platforms that integrate cash flow hedging and forecasting.