August 2006
Management

By Sujit Mundul

How corporates should hedge and benefit from savvy forex exposure management

The term hedging is used to describe a variety of actions that can be taken to protect a company against the risks resulting from exposure to foreign currency exchange rate fluctuations. The cost of hedging, inherent in reducing foreign currency exposure, must be measured against the foreseen loss due to a given currency exchange rate change. This comparison must be a continuous process, since in every country both the cost of reducing exposure and the risks associated with maintaining an exposed position are constantly changing. Below we discuss corporate policies and strategies within the context of a systematic approach to making hedging decisions.

When considering hedging policies to eliminate or reduce foreign exchange risk, a company must select one of the following:

1. never hedging,

2. always hedging, or

3. hedging selectively.

Additionally, if selecting one of the latter two policies, a decision must be made whether to hedge on "a before" or "after" tax basis.

Never hedging: Companies that select the never hedge policy remain open to foreign exchange risk. The rationale for such a policy is that exchange gains or losses in the long run will offset each other. The policy ignores the impact of foreign exchange fluctuations on material costs, local currency sales prices and interest rates. In addition, a blind eye to foreign exchange does not encourage management to incorporate the realities of foreign exchange into their everyday management decisions.

Few companies with international operations follow this policy, as it has proved to be expensive in a number of currencies over the past decade.

Always hedging: A 100 per cent hedging policy is similar to buying insurance without a discount. It can be very costly. Small companies, along with some large corporations, follow a 100 per cent hedging policy on an "after" tax cash flow basis. They follow this policy because they cannot afford to suffer the downside risk.

When this policy is used to hedge not only cash flows but also reported earnings the cash consequences of such a policy are often too expensive even for large corporations. The negative cash consequences result when a company tries to hedge the potential accounting exchange impact. Losses on hedging actions (e.g. forward contracts) are settled in cash while offsetting reported gains are merely accounting entries with no immediate cash flow impact.

In addition to the cash consequences of this policy, such a policy ignores the basis for economic decision making; risk versus reward. The policy does not compare the cost of the hedging to the exchange loss risk. For the above reasons few large companies make use of this policy.

Selective hedging: Companies with a policy of hedging selectively cover individual currency exposures in line with anticipated currency movements. In other words, individual exposures are covered selectively when the currency risk exceeds the cost of hedging. Accordingly, corporations with the policy of hedging selectively usually have an active exposure management function. The currency manager constantly evaluates and reassesses the corporation's risk to currency fluctuations and the cost of hedging such risk. With this procedure comparing the exchange risk to the hedging cost the negative impact of foreign exchange fluctuations can be mitigated. The majority of international corporations follow a selective hedging policy.

Before and after tax hedging: As currency exposures result in a variety of tax effects, corporations often have a policy of hedging on an "after tax" basis. Tax consequences often depend on the type of exposure and the hedging vehicle selected. Accordingly, if gains or losses on exposure are taxed at a rate different from the gains or losses on the hedging vehicle, the amount of the hedge must be adjusted to achieve tax neutrality.

Most corporations find it difficult to respond to rapidly-changing relationships between currencies even if they hedge selectively. More specifically, as the market's psychology and perception of risk change constantly, it is important for the treasurer to allow for a gradual adjustment of a corporation's currency exposure in line with the perceived degree of foreign exchange risk. It is thus important to quantify the currency risk inherent in the corporation exposures.

The degree of risk may be quantified as follows. The company develops forecasts for the currencies in which it has exposure. The choice of forecasters should include the full range of market participants. These exchange rate forecasts are then used to develop a probability range for the market at a future date. The mode, minimum and maximum are used to calculate the potential exchange gain or loss for each of the three scenarios. The potential foreign exchange impact for these three points is then compared to the cost of hedging the same currency exposure for the period in today's exchange markets. If the potential mode exchange loss is greater than the cost of the hedge, hedging a percentage of the currency exposure would be recommended. The Exhibit on this page illustrates how this rule operates for both a net long and a net short exposed position.

Do not hedge: If the cost of cover is more expensive than the mode (i.e. the most likely situation) the corporation should not hedge.

Hedge full exposure: If the cost of cover is less expensive than the most beneficial scenario - the 90 per cent probability range (i.e. max for a long position; min for a short position) the corporation should take full cover.

Partial hedge: Finally, if today's cost of cover is less expensive than the most likely (mode) expected loss, but more expensive than the most beneficial scenario a hedge may be appropriate depending on the risk aversion of the corporation. The recommended percentage of the hedge may be adjusted upward or downward to reflect the risk aversion of the hedger.

To illustrate how the decision rule works, let us assume that Alpha Inc. is a US based company with a long sterling position of $10 million equivalent on December 31, 200 X. The spot exchange rate is $2.10, the cost of cover for one year is 2 per cent, i.e. $200,000 and the 90 per cent distribution of the one year sterling forecast is as follows:

Min: $1.70

Mode: $2.00

Max: $2.40

In this situation, the Alpha Inc. should hedge part of its sterling exposure, because the $0.2 million cost of hedge is less than the most likely expected loss of $0.48 million as shown in the graph in this page.

As shown on the graph, the hedging decision rule would recommend that the corporation hedge 50 per cent or $5.0 million of its sterling exposure. This decision is arrived at by comparing the $0.2 million cost of hedging to the min, mode and max of the distribution curve. The $0.2 million cost is less than the mode's $0.4 million exchange loss, but not greater than the max's $ 1.4 million gain.

The hedging decision rule is meant only to be a guide for making decisions and is only as good as its data input. Should the exposure be incorrect or the forecasted exchange rates non-representative, the decision rule may indicate incorrect hedging decisions. If the decision rule is used properly, however, its gives a company a useful guide to hedging decisions.

Once a decision has been made, the corporation has a number of hedging alternatives from which to choose. The decision making process for determining specific hedging actions must be well-defined, with responsibilities assigned and appropriate authority delegated. Decisions should be reached in a timely fashion and implemented at least cost.

Before deciding on a technique, however, the exposure mangers should consider the following issues:

1. Length of time the hedge is desired;

2. The flexibility of the technique (i.e. can it be terminated, adjusted or rolled over);

3. Restriction imposed upon the operation as a result of the technique (i.e. covenants, collateral and guarantees); and

4. Exchange controls and regulations

(Mundul is CEO of Standard Chartered Bank Nepal Ltd.)

Dying Brands
A Strategic way to Renaissance

by Sanjeev Pradhan

“In the beginning was the brand,

And the brand was with the company,

And the brand was the company”

- Karen Abraham on Brands and Broomsticks

Most brands are dying today. It is not a natural death of obsolescence, but the slow death of sales and market erosion. The brand managers are not complacent! In fact they are constantly tweaking the advertising, pricing and cost of their products. Not specifying to any particular product, this article focuses on the effectiveness to show how well the brands can be managed to lead a strategic way to renaissance.

A fundamental issue can be raised to address the heart of the problem that is mostly faced by the managers today in most organisations: Can the original promise of the brand be recreated and a new spark lit with today's consumers?

Well I believe it can, most brands can be reinvested or rejuvenated through a brand renaissance.

The renaissance of the 15th and 16th centuries reinvested the Greco-Roman artistic tradition. In the Dark Ages that followed the Greek and Roman eras, the church had declared realistic art too sensual and pagan. The artistic principles of antiquity had to be rediscovered at the start of the renaissance to create the rigid low standards.

Most companies today have forgotten what made their brands great- they are lost in their own Dark Ages. Why? This is due to the ineffective business practices that have become their habits, and the powerful connection of great brands to their customers has stagnated or died. The reason behind it reflects the periphery in our market-driven society where rooftops can be anything from tubes of tooth paste to discounted airline seats, to cups of coffee. It's quite a challenge for anyone who is involved in brand management, especially anyone trying to establish, of necessity, a memorable brand niche. The challenge becomes exponentially daunting for "experiential" brands where it's people who are responsible for delivering the brand promise. To do so, they need to be absolutely clear about what makes their brand different. If they don't get it, they can't deliver on it. To put it in simple words: It's all about performance!

Hence in this context, my premise is that, in order to save a brand from a life lost among rooftops environment, companies have to do some visual positioning of their own within the context of brand development work. The marketers need to start with pictures to inspire the pith and power we're looking for. The objective is to peel back the layers of a given brand attribute to discover the particular meaning that the company means to convey and in a way no one else in the category has. Visual positioning can help put into words the physical, the aesthetic and the intellectual nature of something being different - and better - about your brand. And that can be your end game.

Apart from visual positioning, five elements can be applied into business practices in order to create a brand renaissance today.

1. Sound economic system: Brands can thrive if the company has a sound economic system. Sound economies only result when there is a clear trading and banking advantage that generates greater wealth. Such wealth only acts as a basis to fund the renaissance art and a great art can flourish only under a system of competitive advantage that creates wealth for the company.

2. Profound insight: A profound and an infinitive insight into human nature and values is what a great art requires. A deep insight into consumer's needs and especially the dissatisfaction that occurs in the consumers' minds can only be thought of if enduring brands are created. A company has to position themselves as an affordable luxury for what the customer needs and expects.

3. An original paradigm: Companies who wish to resuscitate moribund brands often look to classic models like Coca-Cola and Crest for inspiration but most of the time a successful brand renaissance requires an original paradigm. The original paradigm of Greco-Roman models has invented their own set of rules by developing original styles that has ultimately influenced a host of imitators to think over it.

4. Skilled teams: The great art of antiquity and the renaissance was often created by skilled teams working toward a common vision, under the direction of a master. This shows that whenever any brand is in the dying stage, such great brand can be rebuild through teams, often led by visionaries, but the success is found equally in members having collective and complementary skills.

5. Relentless innovation: Any great art done by a true artist has always been driven by a stubborn pursuit of innovation. A true artist doesn't create great work and then say, "Aha, that's it. I have done it. I'll just repeat that over and over". No doubt, it is a great source of achievement but simultaneously it should push the boundaries to move ahead. Sustaining strong brands takes the same dedication to innovation and improvement in all aspects of brand management: i.e. positioning, product development, marketing and the coordination of the entire consumer experience.

However, applying the above practices can be fruitful for the emerging companies to go ahead and gain powerful images in consumer minds with a significance that transcends their association with any single product or service. It is better to launch any new product immediately before any competition exists rather than face the competition later so as to gain brand equity. Hence, any company who wishes to achieve more with less, can do by:

l Accessing scale economies with limited volumes

l Acquiring expertise without hiring it

l Borrowing technology without developing it

l Delivering to rapidly growing demand without creating redundant capacity

l Growing with limited resources and investment

(Pradhan is an HOD, Management, Himalayan White House College Int'l College and a lecturer of Shanker Dev Campus and can be reached at sanjeevpradhan76@yahoo.com)

Learnings from StanChart Nepal 's HRM

While for most of the Nepali companies the Human Resource Management (HRM) means nothing more than the routine functions of hiring, transferring, promoting and record keeping, Standard Chartered Bank Nepal Ltd. (SCBNL) has at least a couple of things to offer to the corporate fraternity. For example, the autonomy of HR department and proper alignment of HR goals with organizational corporate goals are two such points. Manindra Shrestha, Head of the HR Department of SCBNL boasts: “Based on the HR Roadmap, HR function in SCBNL focuses on people management around three broad themes – Know me, Focus me and Care about me. All people products and processes evolve around these three themes to maximize on our human capital. Our mission is to provide support and guidance to the businesses so as to ensure that HR initiatives are in line with business agenda, drive performance as well as motivate staff”.

Acquisition

Acquisition or recruitment in SCBNL is done in two phases. In the first phase, after the completion of the standard written test as may be relevant, HR personnel and two independent managers interview the pool of short-listed candidates. And in the later phase, Head of HR and Business/ Function Heads in consultation with the CEO take the final decision regarding who should be recruited.

Similarly, the bank maintains a strong HR inventory backed up by well managed HR information system which provides a large pool of competent applicants. Till date there has been no outsourcing of recruitment function by SCBNL though this practice is widespread abroad and Standard Chartered Group companies too follow this in other countries. ‘This is because the current recruitment volume does not justify it to be a viable proposition’, says Shrestha. Moreover, as he says, “our people who have already embedded the values and culture of the Bank as well as are aware of the business agenda best know what we are looking for in the prospective candidates and are in a better position to identify and spot the right people.” The internal search has also been given high importance as and when opportunity arises, he says, indicating that the company follows the ‘promotion from within’ concept to the best extent possible. “It improves the probability of good selection, since information on the individual’s performance is readily available. This concept can also act as a training device for developing middle and top level managers and also gives an indication that if they do well they have unlimited opportunity to rise to the top,” he adds. However, in its constant endeavor to meet increasing business needs and challenges and build the company’s benchstrength, SCBNL is also looking for young talents externally depending on requirements.

Training and Development

Training and development are SCBNL’s core competitive advantages, according to Shrestha. Since the very beginning of the acquisition, training and development activities are carried out at different levels.

While the recruits are trained on-the-job, being a multinational company SCBNL sends its people on short and long term assignments to its various Group points (SCB is operating in 56 countries globally) exposing them to greater workforce diversity and business challenges. Numerous training packages have been introduced in SCBNL by inviting various foreign experts from Standard Chartered’s Group Organization Learning, while the staff members are also sent abroad to attend various training programmes, workshop and seminars thus making it highly capital intensive exercise.

This is apart from the various provisions it has to enable staff to pursue further studies as well as training programmes. “Therefore, I am proud to say that SCBN has well trained and skilled resources who are high performing and have the potential to take up new challenges”, says Shrestha. “Given the pool of highly qualified and competent people we have working for the Bank, many institutions do look on our people,” he says. “The fact that the CEOs and senior managers of many Banks in the market are originally from SCBNL goes to explain the reputation of our people.”

Still, Shrestha says, attrition levels are at acceptable level. “We believe that nobody is indispensable. The Bank is a well established institution with a solid structure in place. We might loose some good people to our competitors, who leave us for higher positions and bigger responsibilities, yet we move ahead because of our effective people planning and management. In fact, healthy attrition allows the Bank to provide learning and growth opportunities to our people who are aspiring to grow in the Bank in line with their aspirations.”

Also the employee orientation and engagement in SCBNL is tremendous with induction courses in the beginning followed by staff participation in various internal as well as external activities. “The Bank’s objectives through these activities are to enhance engagement and morale and create a sense of belonging for the employee with the Bank,” says Shrestha. The Bank has also endeavored to ensure Work Life Balance to its employees by introducing alternate Sundays off.

Motivation

SCBNL uses performance evaluation based on the Job Objectives set out at the beginning of the year. Individuals are rated and performance bonus awarded on the basis of individual performance. SCBNL’s evaluation is not limited to evaluating the performance of its staff alone. The employee engagement level is also monitored through Gallup Q12 Survey. “Standard Chartered Bank believes that teams that are highly engaged create sustainable high performance,” says Shrestha. Annually, the Bank administers an employee engagement survey to establish progress toward increased employee engagement within the Bank and primarily identify areas that need team attention to create a high performance team.

Maintenance

There have not been major maintenance problems in SCBNL since employees are constantly trained and groomed in, what Shrestha calls “a challenging and professional working atmosphere”. Disciplinary problem is negligible, people have feeling of belongingness and have very positive attitude toward their work. In case of any employee grievance, there is an immediate reaction toward the solution. Till date there are no employee union in SCBNL. “The Bank’s attrition rate is at a reasonable level,” says Shrestha. Most of them leave to pursue further studies abroad. Employees who are leaving the organization have to appear for an exit interview.

Let’s hope, other Nepali companies are trying to emulate SCBNL in HRM.

(Bibek Subedi & Manish Bikram Shah)