Insights to Corporate Financial Risk Management

“Despite a continuously changing environment, many public corporate hedging practices held steady from prior years, such as the continued use of swap- and forward-style products, a prioritization of interest rate and foreign currency hedging, and a hyper focus on achieving hedge accounting,” the report says.

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Interest in Interest Rate Hedging

The research found that 88 percent of participating companies face interest rate exposures, and 38 percent of those with risks are hedging. For companies over $20 billion in annual revenue, 98 percent have exposure to interest rates, and 52 percent are hedging.

About a third of companies with an interest coverage ratio (ICR) above six hedge interest rate exposures, while nearly two-thirds of companies with an ICR between zero and two—organizations that are likely struggling to cover their interest payments—are hedging.

Chatham suggests that organizations with excellent profitability and/or low interest costs may be less concerned about variability in interest expense, as their ability to cover interest payments is strong. Conversely, businesses with sizable interest obligations relative to their profitability may be more sensitive to fluctuations in interest expense. Companies with an ICR below zero are the least likely to hedge of any survey respondent, presumably because they are concentrating on improving their chance of survival by restructuring debt or improving core business functions.

Among those that hedge their interest rate risk, swaps—which require no up-front payment and effectively lock the company into a predetermined interest rate—are the most popular instrument, cited by 81 percent of respondents. The total certainty in outcome is clearly attractive to many treasury teams.

That said, 9 percent of survey respondents, and 14 percent of lower-rated corporations, use vanilla options to hedge their interest rate risk. Companies with worse credit that are willing to pay the up-front premium may find options products like caps to be more accessible than traditional swaps.

Keeping Currency Risk in Check

Even more survey respondents acknowledge facing exposure to FX (89%) than interest rates, and nearly half of those respondents (48%) are hedging their currency risk. For companies over $20 billion, those numbers jump to 96 percent and 71 percent, respectively. Chatham found that manufacturing is the industry most frequently exposed to (95%) and most frequently hedging currency risk (60%).

In addition, the survey revealed that the companies most likely to hedge FX are those with earnings before interest and tax (EBIT) margins between 10 percent and 20 percent. The study didn’t ask companies to explain their hedging decisions. Chatham theorizes that companies with operating margins above 20 percent may be willing to accept FX-related volatility to their financial statements, knowing they have a buffer, while companies with profitability below 10 percent may be focusing most of their attention and resources on improving that number.

Like with interest rate hedging, FX products that lock companies into predetermined strike rates are the most popular tools for risk mitigation. Sixty-nine percent of survey respondents use outright forwards and swaps to manage their currency risk. These solutions’ “simplicity and zero-cost nature make them effective hedging tools for operational programs, where [FX] trading may take place as often as daily,” according to Chatham.

At the same time, a notable proportion of large companies use complex derivatives, such as cross-currency swaps, collars, foreign debt designated as hedges, etc. Only 6 percent of companies that hedge their FX risk use options to do so.

Where Risk Management Is a Hot Commodity

Not surprisingly, commodity risk and commodity hedging are both less prevalent; fewer than half (49%) of survey respondents face commodity risk, and only a quarter (25%) hedge it. Natural resources and mining (68%), leisure and hospitality (62%), and manufacturing (60%) are the industries most likely to face commodity risk. They are also most likely to hedge—42 percent, 19 percent, and 28 percent, respectively.

Companies that hedge commodity exposures mostly use swaps and futures (67%), although a full 15 percent use options and 18 percent use other products, such as collars and call spreads. Historical precedence makes a larger array of options-style strategies available for commodity risk management than for interest rate and FX risks. In fact, in 2007, the Bank for International Settlements’ Triennial Survey reported that commodity options made up about half of over-the-counter commodity derivatives outstanding for nonfinancial corporations.

It’s also worth noting that commodity prices overall experience more volatility than do interest rates and currencies. “The physical nature of commodity markets results in extreme cases of volatility, depending on factors such as geopolitics, war, inflation, shipping lane disruptions, government policy, and more,” Chatham’s report states. “Although options come with a price, corporations are generally more willing to employ these strategies in the more volatile commodity space to take advantage of favorable price movement.”

All in all, the survey report concludes, “2023 was less volatile than 2022 in many respects, [but] risk management strategies were still of paramount importance for publicly listed corporations, and it benefits companies to know how others within their industry and across the broader marketplace are managing financial risk.”

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