Improving Business Batting Averages with Balance Sheet Hedging: Cricket, FX, and Mitigating Risk

From a certain vantage point, the world of foreign exchange is a complex game influenced by predictable and unpredictable factors:  Businesses that correctly anticipate market movements and their risk exposure win their games, while those that don’t forecast or understand their weaknesses tend to lose. My perspective is undoubtedly influenced by my lifelong love of cricket — a sport like baseball but with a weird pitching action! — which gave me my first experience of using teamwork and calculation to produce winning strategies. We FX executives can learn a lot about balance sheet hedging from sports and vice versa. Here I’ll elaborate on this comparison to illustrate how we serve our clients at GPS Capital Markets.

Cricket and My Career

As I reflect on the journey that led me to work in foreign exchange, I think about my family’s move from the UK to Hong Kong when I was seven years old. I grew up in London, but relocating to a radically different culture at such a formative age provided memories and lessons that shaped my character and broadened my horizons. My childhood instilled my love of travel, eventually leading to my career and the connection with my wife Maria. It was also in Hong Kong that I learned to play cricket, and my enduring passion for the sport has given me a sense of discipline and perseverance that I’ve used to help my clients score “sixes” (the cricket equivalent of home runs) in their FX endeavours.

Cricket, for those who do not know, is a game played between 11 players a side in various formats. The formats range from a five-day game to a 50-over game, to the shortest format: a 100-ball game. It is played on a round pitch, with the wicket in the middle and stumps at either end of the wicket. Like baseball, there is a batting side and a fielding side, but in most formats, they alternate only once a game. The objective of the batting side is to get as many runs as possible in the time or overs, (an ‘over’ consists of six balls bowled consecutively from one end), available to them, whilst the objective of the fielding side is to get the batting side out by taking wickets. This is achieved by hitting the stumps with the ball, catching the ball, or hitting the batsman’s body whilst he is in front of the stumps  — confusingly known as Leg Before Wicket or LBW. The side with the most runs in an innings wins the match.

Mitigating Known Risks

Cricket, like most sports, starts extremely basic when it comes to mitigating risk. Selecting a bat and putting on protective gear before a match follows the same logic as a company putting basic financial protections in place. In the Foreign Exchange market, balance sheet hedging is basic, you are hedging your known exposure. In simple terms, if you have a foreign invoice due in 60 days, the best practice would be to lock in or hedge that exposure to currency fluctuations. This approach allows businesses to mitigate the potential adverse effects of actual currency fluctuations and their impact on financial statements.

What Are Balance Sheet Exposures?

Balance sheet exposures can range from accounts payable, accounts receivable, inter-company invoices, or inter-company loans. If any of these items are valued in a foreign currency, they are exposed to currency risk. Just like you wear a cricket helmet to protect your head, companies use accepted best practices to hedge these simple short-term exposures.

Implementing Balance Sheet Hedging

Companies typically employ various techniques to hedge their balance sheets from currency risk. This can be complicated by having multiple accounting teams throughout the world. If this is the case, each entity will have their exposure. The best practice is to first, identify any natural hedges the company may have. If you have liabilities and assets in the same currency (matching US dollar loans with US dollar assets), on a global basis, the corporation minimizes its exposure.

Once all the natural hedges are identified, we then need to look at the net exposures by currency pair. Most companies set a hedging threshold based on what amount is significant to them. GPS Capital Markets has the tools available to help companies identify, value, and manage their balance sheet risk.

Results of Balance Sheet Hedging

The primary goal of balance sheet hedging is to minimize the impact of currency fluctuations on a company’s financial statements. By implementing hedging strategies, companies aim to achieve greater stability and predictability in their reported financial results. Here are some potential results of balance sheet hedging:

1. Reduced Earnings Volatility: Hedging can help smooth out fluctuations in a company’s earnings caused by currency movements. By locking in exchange rates, companies can avoid sudden changes in the value of their foreign currency-denominated assets and liabilities, leading to more stable financial performance.

2. Enhanced Cash Flow Predictability: Currency fluctuations can significantly impact a company’s cash flow, especially for international business operations. Balance sheet hedging can provide greater certainty in cash flow projections by minimizing the impact of currency rate changes on revenue and expenses.

3. Improved Investor Confidence: Companies that effectively manage currency risk through balance sheet hedging often instill confidence in investors. By demonstrating a proactive approach to mitigating currency risk, companies can enhance their reputation and attract potential investors who value stability and predictability.

4. Competitive Advantage: In industries where currency risk is prevalent, companies implementing balance sheet hedging strategies may gain a competitive edge. By minimizing the negative impact of currency fluctuations, these companies can focus on their core operations and long-term growth strategies and add value in the eyes of potential suitors, who may be willing to pay a higher price for the business.

In conclusion, balance sheet hedging from a currency perspective is a basic approach that allows companies to manage currency risk and minimize the impact of currency fluctuations on their financial statements. By implementing effective hedging strategies, companies can achieve greater stability, predictability, and investor confidence, positioning themselves for long-term success.

Being a father of three remarkable sons, having a wonderfully supportive wife, and being an enthusiastic cricketer have also given me the skills to provide excellent service and build balance sheet hedging programs for clients. Diligence, accuracy, research, and testing are all needed when we at GPS assess a client’s portfolio of currency risks, just as needed for maintaining a prosperous family life and playing in a successful cricket team.