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Guidelines for long-term FX hedging

The nose-dive in the NZ dollar value from above 0.8000 earlier this year against the USD to around 0.7000 has pulled down several of the cross-rates to other currencies to historical cyclical lows. The NZD/EUR at 0.4700, the NZD/AUD was below 0.7800 and the NZD/CAD at 0.7450 are all near to 10% below their 5 or 10-year average rate. Many exporters operate a FX hedging limit/policy regime that allows long-term hedging beyond 12 months, out to three and five years forward when spot or forward rates hit such “filter-tests” of being more than 10% below the 5 or 10-year average rate. Over the last 10 years APRM has recommended that (after robust testing) many exporting companies adopt such a conditional hedging policy. Those exporters who actioned such long-term hedges in 2000 and 2001 certainly saw the benefit of the longer-term hedging horizon. However, hedging export foreign exchange risk beyond one or two years forward requires awareness and certain pre-requisites:-

  • A high level of probability that projected export sales in that currency will be achievable. This requires conviction and accountability not only from the Treasurer and CFO, but also the CEO and Board.
  • The maximum hedging limits for 3, 4 and 5 years forward are probably below 50% and descend the further forward they go – thus forcing an “averaging-in” build up of cover in the hedge-book over time.
  • The level of long-term hedging with forward contracts only is strictly limited with additional higher maximum limits with purchased options only.
  • Long-term hedging may be in the form of three and six month currency option contracts that are “earmarked” to be converted to longer-dated forwards on expiry (exercised or not).
  • Exporting companies that can adjust their foreign currency selling prices in response to NZD currency movements are less likely to hedge long-term, than exporters that cannot.
  • IFRS accounting treatment and likely impacts to future profits/Income Statement must be modeled and understood in advance.
  • Bank providers will need to approve FX dealing limits for longer-dated contracts. Exporters must know in advance the amount of credit usage the bank will assign, particularly if the long-term forward contracts move “out-of-the-money” on a mtm revaluation.
  • Leveraged, digital, knock-in/knock-out and collar options should not be used in any circumstances for long-term hedging. Purchased OTM NZD call options will not straight-jacket future hedging opportunities.     
DISCLAIMER: The information contained in this document is given in good faith and has been derived from sources believed to be reliable and accurate. However, neither Asia-Pacific Risk Management Limited nor any of its employees, gives any warranty of reliability of accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions herein.