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Global FX Exposure - stephenkhoo - 09-04-2013 10:56 AM
Case Study: The Management of Hubbell Inc’s Global FX Exposure
Howard Wardlow, Hubbell Incorporated - 2 May 2013
US manufacturing firm Hubbell Inc experienced a rapid expansion of its global foreign exchange (FX) exposure, and found that current processes were not effectively measuring and managing this growing risk. Exposure visibility was low, and the corporation was exposed to unexpected and significant potential FX losses against its earnings. It assembled an expert project team, including several senior finance executives, to identify and implement a solution to ameliorate this issue. This case study illustrates its new FX risk solution.
Hubbell Incorporated has been in the happy position of enjoying strong growth over the last five or so years. This result has been achieved primarily through a series of corporate acquisitions, some of which had international - namely, non-US-affiliates. International business now represents almost 20% of Hubbell's consolidated business volume in its core manufacturing field, which reported a US$3bn figure in fiscal 2012. This represented an increase from the previous single digit rates of international business. Such growth presented the finance and treasury functions with new challenges, including identifying and managing a sharply increased global level of operations and a diversity of foreign exchange (FX) exposures.
In addition, we were confronted with the technical complexities of exchanging critical financial information with a single instance of SAP and other legacy accounting systems, explains Hubbell's Howard Wardlow. This was the means by which we had to measure the FX exposure across the group. Without action, we were potentially at significant risk of suffering unanticipated FX losses, since the global exposure was not fully visible. Also, we lacked the essential analytical and reporting tools to manage and interpret the data, which was originating in a complex pattern, in all areas of the group. Clearly, we needed to take swift and effective action, to achieve a significant enhancement in the quality of our corporate FX exposure management, and of the related management reporting.
FX risk had grown sharply across the entire Hubbell organisation. The largest exposures were in the currencies of Australia, Brazil, Canada, China, the eurozone (primarily through commercial exposure to Italy), Mexico, Switzerland and the UK. This mix shows how broadly Hubbell was exposed to some of the world's most volatile trading currencies - and the scale and complexity of the FX exposures was growing.
The sustained consequences of Hubbell's elevated levels of FX exposure were obvious: the consolidated corporate profit and loss (P&L) statement reported, on average, US$2m of FX volatility in recent years. This metric provoked a much closer look at the FX area. We had been used to successfully managing the demands of the US domestic economy, but now we were experiencing significant buffeting from the more complex weather of the global marketplace. It was clear that we needed to develop the capabilities and sophistication of our treasury and finance operation as quickly and pragmatically as possible, to enable us to forecast, measure and manage this currency risk. If we did nothing, we knew that the risk of a sudden significant US dollar (USD) FX loss hitting the corporate P&L statement was unacceptable to senior management, and we must therefore act.
Momentum for investing in the essential process change was growing within the Hubbell treasury and finance operation. We measured that even a 50% global FX exposure mitigation would have a positive impact on our P&L. Our team's analysis had brought us to this confident and clear conclusion, but at this initial stage, we did not yet know the real extent of our global exposures. So we had simply established that we were flying relatively blindly, above this unpredictable and stormy global ocean, as it was driven by the forces of international politics and economics.
The one thing we did know clearly was that we absolutely had to put in place an effective global process for dependably measuring and reporting Hubbell's global FX exposure. This meant efficiently identifying, harmonising and validating the disparate accounting data across our complex international business. Converting validated GL data into a single trusted truth would comprise an essential first step towards optimising FX exposure management for us. So it was clear not only that we had new, intensified levels of FX-related P&L volatility to manage: we could also confidently predict that this situation would continue to grow in complexity and risk, in direct proportion to Hubbell's international business growth and diversification. In the practical environment of international commerce, determining the true nature of the accelerated and amplified risk was becoming an increasingly challenging issue - and one of increasing importance to the growth and profitability of the organisation.
It is important to recall that these business challenges at Hubbell were taking place against the backdrop of the emerging global financial crisis and the nascent eurozone crisis. This environment obviously contributed to FX market volatility, but it also meant that successful companies like Hubbell had to battle with a widening range of additional and generally adverse financial conditions, including tightening credit availability and the widespread deterioration of counterparties' creditworthiness.
Problem analysis
Looking for resolution of this FX exposure management issue, the Hubbell treasury team quickly identified the primary business issue. It was based on the simple fact that we did not have the necessary time or resource capabilities to aggregate, validate and analyse the complex constituent data of the current commercial situation to have proper visibility of the company's consolidated corporate FX exposure. When we analysed the question in more detail, including through conversations with our peers in large and successful US multinational corporations, we found that international business issues require quite high levels of analytical expertise and experience to be brought to bear to help to identify a cost effective - and, most importantly, business effective - solution for major pain points.
No two corporate treasuries are exactly the same, and the methods and solution that have worked so well for us may - or may not - fit every case. For those confronting similar situations, I would simply counsel the thorough testing and application of any potential solution's methods, value propositions and assumptions in your unique operating environment. Test the solution's capabilities against your realities; and verify your findings against the experiences of respected peer group users. With the approach we took, we were able to validate, verify and test our selected solution in a matter of weeks, and this up-front investment was well repaid through a very successful outcome.
Like most multinational corporates (MNCs) which have grown through active merger and acquisition programmes, we faced the difficult challenge of identifying, harmonising and validating a plethora of raw GL data so that FX exposures and risks could be effectively managed for the expanded - and expanding - organisation. And we had to ensure that all current finance controls and reporting functions continued to be properly performed as we addressed this new currency risk issue. We were operating a substantial cash management and cash accounting operation, and the integrity of these vital treasury processes needed to be secured as we developed our FX exposure risk management resources and capabilities.
In a realistic internal risk assessment, we concluded that we simply did not have the necessary in-house experience to design and deliver an optimal solution. No one had set up such an FX programme from scratch before. In addition, the continuing rate of corporate growth demanded that we should build or buy an effective solution as quickly as possible. With a little investigation, it became very clear to us that the most cost effective and lowest risk approach was to select a proven and well-referenced third party solution.
Solution selection
Hubbell organised expert project teams for selection and enrolment, involving key people from treasury, financial planning and analysis (FP&A) and IT. The make-up of the teams was designed to ensure that all the relevant business areas and issues were properly represented, and that all users would experience joint ownership of the resulting solution. The selection team was eight strong, and comprised:
•A director of financial planning and analysis (FP&A).
•Manager of FP&A.
•Director of finance and treasury.
•Vice president (VP) and treasurer.
•VP and corporate controller.
•Senior financial analyst.
•SAP FICO lead.
•Financial institution (FI) support analyst.
We sought to achieve a balance between senior executives, middle managers and expert users on the Hubbell team.
The team identified and evaluated three alternative solutions. We employed a rigorous selection process to maximise confidence that we would be able to recommend to management a vendor and solution which would represent the lowest level of risk and the greatest potential contribution to Hubbell's financial operational excellence globally.
Eventually, Hubbell selected FiREapps FX OnRamp. FiREapps FX OnRamp is designed specifically for treasury and finance organisations seeking to quickly establish an institutionalised FX risk management programme for the first time. It combines a pragmatic and proven three-step methodology with cloud-based applications that enable treasury and finance teams to easily harmonise and validate disparate GL data from their underlying systems of record so they can effectively analyse their complete portfolio of exposures on demand. That accurately describes our priority FX exposure management solution objectives; and that's exactly what we accomplished in practice. Working closely with the FiREapps team, we had initial exposure visibility from our core SAP system in weeks, and rolled in our remaining systems within the two quarters we had planned for.
Enrolment
Hubbell and the FiREapps team jointly planned and executed our enrolment plan, on time and within Hubbell's original budget, within two quarters. 'Enrolment' is the technical term FiREapps uses to describe the solution rollout for a client. As a Software-as-a-Service (SaaS) application, FiREapps does not require traditional software implementation and integration projects; instead they provide enrolment services to help their clients get up and running quickly without the need for hardware or IT development.
The joint team maintained continuity by appointing the same executives as the selection team, minus the vice presidents, to deliver the solution. Additional members of subsidiary IT and Finance were involved in the rollout, as we have non-SAP systems from which we required trial balance extracts for a complete analysis. Using the standard templates provided by FiREapps limited the IT resource requirements to about eight hours per enterprise resource planning (ERP) system - making it practical and cost effective for us to gain full visibility into our enterprise exposures.
The actual enrolment exercise comprised of the following three-step process:
1.FiREapps FX experts worked with the Hubbell team to identify all sources of balance sheet exposure across all corporate entities, and across all extant currency pairs.
2.FiREapps provided a standard template for gathering and uploading GL data from SAP, and also from the various other ERP systems that are in place across the Hubbell global organisation. The technology had to handle quite a complex systems and operating environment.
3.Hubbell started working with FiREapps reports and analytics within weeks. The information was reported in local, transaction and reporting currency detail, enabling the Hubbell team to take informed decisions.
Benefits analysis
The really critical benefits we realised from the FiREapps FX OnRamp solution include:
•Identification of our FX exposures on demand, eliminating many sources of delay and human error from the data gathering process.
•Institutionalised data integrity processes. Pre-built FiREapps templates provide a standardised and secure mechanism for treasury and finance to automatically extract and upload GL data from SAP and other ERP systems. Together with proven validation analytics, this facility measurably improved data integrity - and more importantly, user confidence in making FX exposure management decisions based upon real-time analysis of a single, complete and trusted view of enterprise exposures.
•The FiREapps reports and analytics installed provide the Hubbell treasury and finance team with its first clear view of all currency exposures across several key dimensions, including corporate and legal entity, monetary asset and liability class, and general ledger account in local, transaction and reporting currency detail. Hubbell's quality of FX risk management and overall financial operational excellence is therefore significantly enhanced.
Over time, we have found that the structured data extraction which is possible with the new system via templates, allied to its robust data integrity checks, rules-based exposure definitions and management of new static data, provide us with a very robust platform. The treasury, accounting, and FP&A teams can depend on the quality of the information and analysis with which they are being presented, and they can therefore confidently focus on their value-adding tasks of financial scenario analysis, decision support and reviewing strategy and results with senior management.
Some additional benefits that Hubbell has achieved through deploying the FX OnRamp solution have accrued once a baseline of understanding about the balance sheet exposure was successfully established. As part of the enrolment process, FiREapps risk analysts worked with the Hubbell team to further define the associated FX risk, and to examine various internal and external approaches to manage it cost effectively. The vendor's analysts effectively communicated their expertise to the Hubbell teams, enabling us to achieve a significant improvement in the quality of our risk management operations.
The Hubbell team basically had zero experience with setting up or even running a hedging programme so FiREapps help was greatly appreciated. The implementation team from the vendor walked us through the whole process, and have been very responsive to our requests. I personally have a much better understanding of the FX process and what is considered an exposure and why. FiREapps' expert input has greatly increased our understanding of the process, and of what we need to analyse and review in order to maintain an effective hedging programme going forward. I would highly recommend FiREapps and the implementation team of Karli Vold and Fikre Bizuneh without hesitation.
Additional benefits we have realised include:
•Establishment of a benchmark for the company's FX risk. This is based on FiREapps' proprietary Value at Risk (VaR) tools, working with complete, accurate and timely data inputs. Hubbell gained a solid understanding of the relationships between their internal financial processes, and how they contribute in practice to increasing or mitigating FX risk.
•Identification of new ways to reduce or eliminate exposure and risk organically by cleaning up intercompany flows, closing out open accounts payable / receivable (A/P and A/R) positions, and converting non-functional currency cash balances located in foreign bank accounts.
•Visualisation of currency flows and hedging scenarios via simulated 'what-if?' trading operations and the use of FiREapps' patented CoRE analytics to fully understand the potential costs and benefits of adopting different exposure management hedging strategies. This helps Hubbell to identify and implement the optimum hedging strategies that comply with commercial requirements and with treasury risk management policy.
Hubbell has significantly enhanced the quality and effectiveness of its FX exposure management programme in just two quarters last year with an effective team effort. In essence, the company's FX risk analysis capability has been transformed from a base position in which the team were unaware of the specifics of the organisation's FX exposure, to today's reality in which the Hubbell team - and their management - enjoy the benefits of a new, best practice information management, analysis and reporting environment, leading to effective hedging decisions. The organisation is on its way to significantly reducing its risk of incurring unanticipated FX losses, and is better protecting the value of its foreign currency earnings and profits.
We can now see and understand the exposures, including ones originating from new international acquisitions. This enables us to quickly identify adverse transactional exposures from balance sheet accounts. We are effectively managing currency pair risk in compliance with treasury policy, according to our pre-defined cost/benefit parameters.
Next Steps and Conclusions
Looking ahead, we can now build on a sound basis to make more advanced developments in our FX risk management strategy. The patented FiREapps CoRE Analysis tool empowers us to evaluate risks against costs, and to make quick, informed decisions on whether to hedge - or not to do so. We are using a highly automated and standardised data extraction process, which minimises the initial enrolment and on-going operational burden to the businesses; in essence, the business units send us files of the required data, and we take it from there.
Traditional integration approaches in a complex systems environment like ours can be very demanding for various technical and operational reasons, and hence we really appreciate the automated processes we can now use to extract the necessary information from across the enterprise on demand. Furthermore, we are looking to extend the benefits of the FX solution for the management of transactional exposures in the future.
I would recommend that corporations who are wrestling with the complexities of FX exposure management consider what we have managed to achieve at Hubbell, and see if such an approach would add value to their treasury and finance operations.