Director, Treasury Advisory,
Thank you for joining today’s session on risk management and hedging across the internet and FX. We have today with us. Siddharth Basu, director, Treasury advisor, an advisory from Chatham financial. So there’s a signboard being circulated. Please make sure you have your name and email addresses on them. It will help us to give you the presentation slides through email and also help you gain one credit for CDP recertification. So Siddharth the stage is all yours. Welcome.
[0:36] Siddharth Basu:
Thank you again for attending. You are the few but, the mighty especially. But I was at 4:15 you know, choosing to learn about derivatives theoretical being at happy hour so fully acknowledge that. So my responsibility for the next 30, 40 minutes is to make sure you have a good time to review up for the happy hour and the dinner. And along with that hopefully, you learned a few things about derivatives something about me, then maybe a Disney movie. Before I get started, I’ll do a brief roll call. How many of you work on hedging or derivatives? Weekly, monthly, according to this or have worked on it before? All right, you guys are gonna be the expert in my life. And how many of you know cringe when you heard the word derivative? If you watch The Big Short at the weekend time, it’s not what you want to enjoy, the others. All right, you guys have soon to be experts. So we’ll make sure there are some interactions. All right. This way no presentation and derivatives are complete without a little bit of legalese. Just, you know, just as you guys watch those wireless home videos, there’s always that sign that says, do not try this at home. This is the Dodd-Frank version or does it before you go and enjoy derivatives you must have your tax legalized with the business transaction advisor.
Once you’ve done all that, you can go to yourself. You can do derivatives all day long. Myself, I’m based in Denver. I’ve been the chairman for five years, predominantly focused on helping companies identify risk or industrial effects, manage that and then come up with strategies.
[2:18] Siddharth Basu:
And prior to Chatham, I was with Ernst and Young in Minneapolis a little bit in time in Chicago and in Denver. So what does Chatham do? Chatham is the largest independent advisory firm when it comes to getting into it. We span across sectors. Our private equity group works with KKR Blackstone, we’ve got financial institutions team that works with the middle-market community, smaller regional banks. Anything that you feel that if this is the institution category. We got real estate, that’s actually how the company started working with funds at anything that’s real estate related. And then anything else that doesn’t fit into that those three buckets is corporate. So that would be a widget manufacturer, your tech companies, your medical device companies to airlines. All of that is incorporated and I do corporate. The reason it’s split up into four is that risk management objectives can be different for each category, which sector.
We’ve been in business since 1991. We’ve got seven offices and based in Denver, we have our headquarters right outside coming up here. And then we’ve got an office in London, one in Krakow, Poland, one in Melbourne, Singapore, and then Toronto, Canada. We’ve got lawyers, basically, we do end to end so from the onset, if you have seen Big Short, you’re trying to figure out what it is. That’s what the lawyers and our team do. They help you negotiate and to figure that out. Once that’s done, we will go on a hedging strategy, that’s where I come in past, I got hedge accounting superhead accountants 60,70 of them from predominantly big fours or as big something’s and then on the back end and we have guys doing quantitative analytics to value the streets. So over the next 30 minutes now we’ll look at the market landscape, why should we be concerned about what’s going on why should we even talked about this. Will talk a little bit more interesting and that’s what I’m going to look to my lifeline and then also look to you for the soon to be experts, to ask questions and then we’ll look at spending a little more time in the FX side because it tends to be slightly more complicated and then eventually a bit more Q&A if you haven’t already asked questions. So. here you know, sometimes I find visuals help you see what’s going on better than words or text.
Any guesses to when people hear a thing of course on Brexit? 2016 June and what are we in? We’re in February 2020, is Brexit done?
[5:03] Siddharth Basu:
Its a trick question. So the agreement is signed as of last Friday, the transition phase is going to happen by the end of this year. So it’s been holding up the headlines should it be if you think about it, UK is a USA’s seventh-largest trading partner. But it’s been in the news and in anytime you see such disconcerting news, it creates uncertainty and volatility in the markets. The other big news, China, you can go past one page of the Wall Street Journal without coming across China a few times on pages. Sometimes it’s mostly technology related. Sometimes it’s political, social rights, and they are inspired. There’s always China. There’s always something going on. And that’s normal. We’re going to see China and it is a long time. And crude as a proxy for just overall commodities markets. Over the last years, we’ve seen whose prices dip will not have been 110, 120, that was 70 years ago. We’re now in a stable 50%. Even then it jumps 5-10 percent month to month. So overall commodities have been a major concern as well.
[6:08] Siddharth Basu:
When you look at the global landscape, in addition to China and Brexit, there’s two major influence. One is slowing growth. So when you look at China, obviously they’ve had their experience, this past year when the data came out on their smallest growth in 27 years. You look at India, which was the largest, or the fastest-growing country up until three years ago, and now it’s 4 and a half or 5%, which is very slow compared to what the potential is. So slowing growth is one and the other one that’s related, predominantly one might be causing the springboard is trade, tariff action. So nowadays, the two countries get into verbal fighting, match or tweet, what they do is respond to the tariff. So tariffs have become commonplace, the World Trade Organization, which was the overseer of trade transactions, it’s almost becoming the default.
So it’s creating more pressure and volatility in the markets. And then when you look at the interest rates market, it’s up, you’re going to get a look at some graphs and charts. On the top left is a 10 year Treasury. Treasury is important because that serves as the bellwether for economic activity. So all your student loans, your auto loans, credit card, a lot of them have an embedded component to trade within the Treasury. Last year, we saw it go down potentially. It made sense because the Fed had been cutting rates three times. Since then it’s stabilized. In fact, the Fed has now become come out and said we’re going to be more policies. What that means is, it will stay the course unless it’s data is pointing to either increasing rates or decreasing rates. On the right you will see the PCE, this is the feds preferred metric as it looks at inflation and that has been under 2%. So when the PCE or the inflation is kind of 2% for February, it doesn’t have much ammunition to increase rates.
[8:02] Siddharth Basu:
And now to my soon to be experts, we’ve got a couple of things swaps and caps. I’ll explain this in detail. But right now, when you look at the left graph, swap rates, the near term. So when you’ve got a loading rate loan, and you’re fixing it by getting a swap, that swap rate is looking inverted the near term first one or two years, flattening slightly past that, and then it’s looking upward sloping. It creates a little bit of business and uncertainty. If you think about, should I go out there lock my rates? Or should I write down? And then you also want to think about what is that term? Am I looking at five years, 10 years, it’s 5, 10 years and it’s upwards a little bit, maybe makes more sense. And then a data point between swaps and caps. We’ll revisit this in a second swap enormously popular and there are good reasons for that, or I’ll show you caps also have gained popularity.
What you see on the left is market data points from 2018. And then on the right areas more recent, probably 20, a little bit of 2018 going into 2019. And then one thing if you’re interested to know, trying to identify more with current commodity, or in the current interested market, Chatham is beyond just looking at just our transactional volume and data, we also do this comprehensive study. So we look at 1400 public companies and their filings and see who’s got exposure across three asset classes, who are hedging that and also applying how to carry. You slice and dice the data across sectors, cross-industry revenue size, so gives us a very good insight into where do we see what differences do we see between industry sectors and companies as they’re thinking about risk management, this would interest you if you just Google chat and financial benchmarking, so you to a typical landing page. You can sign up and some of the chatter will send it to you.
But this thing will generally point to you that interest rate exposure to highs that’s what most companies deal with, its followed by FX that’s the second-highest more common, most common risk and then followed by commodities slightly lower, but still significant. When you look at a trend of hedging or just managing risk we’ve seen in 2015 when we last did this study, and then I should say 2016 was our last study using 2015 data and 2019 when we did the study using 2018 data, we’ve seen more companies are hedging interest rate and foreign currency. But fewer are hedging commodities.
[10:29] Siddharth Basu:
Make sense to some extent. In fact, it makes more sense, you start thinking about commodity prices have seen a downward trend. So companies really have targeted or thought about their program and their policy and said maybe I don’t need to address commodities. On the other hand, interest rate FX has been popular, so companies that really don’t in managing that risk. Well, we’ll talk about the interest rate, but before I do that, just another poll, how many of you are aware that your company’s dealing with interest rates?
[11:05] Siddharth Basu:
I would like to talk about three products that are most commonly used. Hopefully, that’s helpful and ask questions as we go along. The first more common one swaps what you’re doing. You know, when you think about an individual going in try to get an auto loan or mortgage, that’s generally fixed. That rate is not jumping month to month. Then what happens when a company walks into a bank and says I need a billion dollars in a loan, what are they gonna say? They’ll say, Yep, absolutely. But in between here’s your rate and the rate is broken down by LIBOR. That tends to be the most common chunk of it. And then there is a spread, just one side note of LIBOR going away. That’s a slightly advanced session, but keep that in the back of your head. If you hear LIBOR, also, you should be hearing alternate reference rate. But for now, we’re living with LIBOR. So when you get this LIBOR press spread, the only thing that static or fixed is a spread portion, LIBOR is moving, day to day we think so when you think about cash management, about how do I manage this fluctuating amount of money that I need to pay?
[12:11] Siddharth Basu:
A lot of companies say, well, the best way to do that is to go get a swap. All you’re doing is you’re turning around. You were saying I will go find somebody who gives me LIBOR so I can pass it back to this bank, give me the loan, then I’ll give them fix rate. Now, that fixed rate can be an advantage or disadvantage, it really depends on what the current rate is. So once you’ve done the swap, and you’ve got this fixed-rate, if rates go lower, to that you’re stuck with that fixed rate, which goes higher, you benefit because you’re locked. What then happens a lot of companies say well, I don’t want that lottery, the return rates are gonna go lower. I want to have the benefits. I want to enjoy the benefits of lowering. So that’s when caps come in. But nothing there, there are no free lunches, just like those caps. You have to pay for it. So there’s a premium upfront. But then what you’re doing is you’re establishing that ceiling, that if rates go above this, you’re covered, you’re going to exercise your cap. But then if rates go lower, you say, you know what, I don’t have to worry about this. I’m not going to exercise my cap. I’ll just benefit from the decreasing rate. If that’s what you know if that’s not palatable if you say you know, I don’t want to pay for that. I don’t want to pay the premium. How do you address that? That’s when color it’s coming. Yeah, no free lunches.
But what you’re doing is you’re buying a cap, so you’re buying the upper ceiling. So let’s assume if rates for your upper ceiling rate is 4%. If the LIBOR and your spread, if LIBOR goes about 4% -5%, you would cover it at all. But on the other hand, what you’re doing is you’re selling the floor, so just saying, I am going to sell it a 2% so if rates were between the 2 and 4%, you are going to experience the fluctuations there is going to be noise or financials. If it goes below 2%. Again, you will be covered. So it’s that trade-off between giving some and getting some. Talk about the advantages and disadvantages. The other thing to keep in mind is as you were thinking about these three products, it’s also important to think to the education side of it if that’s crucial there can be slight nuance treatment as it comes to collars. But just real brief poll, how many of you have used swaps, or caps? How many more minutes to wrap?
[15:11] Siddharth Basu:
We’ll do FX next. Now when you think about the maturity lifecycle of companies, typically 91% as you looked at that statistic earlier, 91% of companies are exposed to interest rates because that just tends to happen. You’re trying to grow your business, you’re going to get a loan and then it’s going to be floating. So most businesses have got an interesting component, but not everybody is directly impacted by FX. You’re going to be impacted indirectly let’s say your suppliers are buying something from China or somewhere in Asia, but you’re buying from your supplier in US dollars. It’s not direct exposure, you still have indirect but companies look at it as has not been a major risk. Because you really can’t manage your suppliers to be one acting on it.
Deloitte did a survey a couple of years ago and try to ask what’s the number one concern treasurers have? FX more truly was high on that list, to be honest with you now that we’ve moved along in time, it’s this changes. FX, I wouldn’t say is always number one, it tends to be in the top three, definitely the top five. There are more things that are liquidity, but FX still keeps appearing like one of those items were treasurers, are struggling to figure out, do I have the best plan in place to address it? Over the next 15 minutes, we’re going to talk about this framework. But before I do that, I’ll just tell you a little brief story.
I was growing up in India you’re wondering where this amazing accent is from? It’s from India and Minnesota and Colorado have a large pie. And I grew up watching I don’t know how many of you have seen Bollywood movies or heard of them. A little plug here. Karthik is very representative. In India you know if you know, I was super excited. I wanted to be in the movie industry, not because I look good. would have done something in the backseat. But I went and told my dad, this is what I want to do. He said there are two paths, engineering or doctors that would sum up your seventy-five percent of the Indian population. Or the third is a street bum. So if you want to be a street bum, the movie industry is your work, so I didn’t get the first two, I wasn’t good enough. So here I am doing derivatives in America. But my love for movies is still persisted, to such an extent that I’ve got a three-year-old daughter. She doesn’t watch any movies doesn’t like anything yet. Hindi or Indian movie in perspective, but she loves Disney movies. And one of our most famous star and favorite movie right now is Moana. So to help you remember this framework, I’m going to go through Moana and maybe a poll. How many of you have seen Moana or the others who’ve not? This is the plug.
Disney’s not paying me but I just hope you enjoyed the movie. Now, why Moana? If you think about this story, it is really about the protagonist, Moana she’s going on a conquest just like anything. There are hurdles, obstacles and that she has to overcome she gets. It’s a psychic, Maui, and then eventually she gets. So that will be the journey, we will go through in some sense. If you start thinking about managing effects risk. Think about Moana’s story, she first starts off, wanting to go on a voyage. She goes to the edges where parents tell her no more passes, she does it what happens? She has a little bit of a shipwreck or city or single brick gets pushed back into the shorts. That’s called aimless wandering. And then what happens after that, she goes to her grandma Tala. And then her grandma says, you know, here’s a very specific objective.
Take this Greenstone to go find Maui and then go put it, to keep that’s kind of the whole story. That is very clear, very identifiable, and every action. So when you think about companies, a lot of companies that we work with initially are thinking about I want to manage excellence that’s not specific enough, to be honest. It really depends where you are in the cycle if you’re a private company, the metric or the objective tends to be more of managing my cash flow, managing my economic risk. As you’re moving along the maturity lifecycle or when you will be public. It’s more of an accounting-based metric. And that’s when complexity starts arising. Between public companies, there is a good mix of some companies you will think about EBITDA. In fact, how many of you are, you know what is your metric is at your company? EBITDA or some adjusted measure, you get that has to be a priority at a public company.
[19:29] Siddharth Basu:
Net income ups still significant, still important.
And needed analysis for a recent company trying to just figure out and they were trying to figure their answer the question, what’s my metric and how should I address it? Before trying to answer that question, we said, well, let’s just map out your exposure summary. When we look at EBITDA, what does your exposure summary, your global footprint look like? And that’s the top left. You will see I’ve circled the cad because they were long cad from EBITDA perspective, we’ll be also looked at from an income perspective because you’re a public company and you have to report everything. And that’s, that’s important. And then in income perspective, the cad suddenly from a long position when the short, it’s knowing what’s causing that. Any guesses to what may have caused this.
[20:18] Siddharth Basu:
My experts were our lifeline.
[20:22] Siddharth Basu:
It was depreciation we had major capital investments in Canada as they opened up offices and then the depreciation pointed to worse figures. So it was not any better figure. It was not an operational issue. It was more of a northerner enhanced statement. So knowing that is important.
[20:40] Siddharth Basu:
There are other ways to the extent you how you’re dealing with this capital affects noise or the depreciation that you know, want to hedge. You can start doing a reconciliation show, here’s my adjusted EBITDA, that’s my top line, number and then doing this reconciliation. Now one thing to say that’s not really taking it away, and it’s not necessarily taking away the noise. It’s just showing it differently. And all. The other disclaimer here is FCC has been a little harsh on these non-GAAP metrics. So just make sure your peers are doing this. And if you’re considering this, just understanding what is actually going to the FX. Depreciation, maybe more may have a more justifiable cause. But if its revenue is that if you’re trying to parse that out in the bottom, that tends to be that’ll be highly scrutinized. The other way a lot of companies have done it is they’ll still report their financials just the way they are, they’ll show some constant currency. Have any of you do comes from constant currency reporting? This is from Apple, Apple’s financials. Years ago, 2015 was a hugely volatile year, Apple decided to do that year, that quarter will do constant currency because we do want to show that our operations have done phenomenally well. But then when I look at from FX perspective, there’s been a ton of noise there and we don’t want the narrative to be lost in terms of what they did because there was regular GAAP reporting and the ultimate GAAP.
[22:06] Siddharth Basu:
Moving along back to our Moana story. So Moana is now out in the ocean and she’s trying to find Maui, she does and then Maui does this math calculation to figure out quantifying the woods. Is it worth losing life and limb to put the screen stolen some arguments is math says again, not very statistical but says an hour? So he puts Moana in the cave and runs away, takes the boat and running runs away. So that’s kind of what’s important when you’re thinking about managing FX risk, some level and rigor of understanding are in the material is important. Not all FX risk is worth hedging. In fact, that’s one of the most common misconceptions people have just because we’re derivatives and hedging guys, you don’t come in and say you’ve got to do everything and as much as you can, it’s really about what’s material what’s causing noise, and focusing and cooling down and just that. This is a statistical model obviously, that we do, there’s a lot of things that go in there. But there’s a lot of tools out there even outside of what we do that you can do a statistical analysis and get to that answer.
This is one way of looking at it. We’re just showing you on a one-month basis if a company is trying to figure out what’s my risk, here, it’s 2.2 million, or one month for a company, let’s say besides an apple, nothing, they’ll just say we are not doing anything. For a smaller company, they made say of 2.2 million is huge for my bottom line. And then we’re also qualifying on a 12-month basis with helped the company thing too. As I’m speaking the model is giving them figures in numbers. My worst case is 7.9. Again, not it’s not the likeliest outcome, it’s just saying what by worst case. Helps them and your street understand how bad could it be? Here’s one example. This is Apple again, trying to say what’s the maximum one-day loss that they confits. This is probably the most recent advancement and they’re saying over one day, the maximum loss is $452 million. So really we’ve done the statistical analysis of their community in a district that if things go really bad and really, really bad worst case, what will the company do. Where the size of the company is as an Apple, not a big deal, so they’re not. But it is they’ve gone through the process in schools.
[24:25] Siddharth Basu:
House of hedging. So, back to our story.
[24:29] Siddharth Basu:
As Maui is thinking about going on this journey, what’s his cost? Does anybody know? What is most concerned about? It’s the hook. So he’s very concerned about this over they go down into the depths of the sea and get this from the shiny crab. They get this hook and he’s super conservative. It’s from god’s supervisor. That’s similar, but a lot of companies need to think about, what is the cost? There are no free lunches, there’s going to be a cost no matter what instrument you’re using the effects night. Most companies use FX words. That doesn’t mean that’s always the right instrument. And then but then there are also companies that are using option products or dollar type products. Beyond just the four points or the debt option premium up these other costs are like maybe the cost of technology if you’re buying a separate resource cost of people overhead so that that all adds up. So it’s understanding if you’re going to have a hedging program, what does it mean to yours. Do we have people around the if you think about how to allocate budget? Keep going, how much time do we have 10 more minutes. But the last one strategy considerations back to Moana again, she’s gonna go in and she’s gonna put this green stone but her strategy and Maui is part of this too is to my is going to evade and distract the monster and then she’s going to go into the side and rolling rocks and get in. That’s what strategies like.
Now, we’re FX hedging is not as simple. Obviously, there’s a lot of considerations around. Do I hedge at the parent level? Do I head to the sub-level? What currencies do I hedge? Do I hedge margin or remeasurement? Then I’ll touch on that in a second. And it has a ratio is 10 or so a lot more goes into the equation. It’s, it’s thinking through as you were setting it up, margin remeasurement visual is probably better. How many of you know the difference between balance sheet risk and capital risk margin? Okay, you’re looking at the graph. margin is you can call it cash flow risk, but it does not cash the way a lot of people especially in a conference like this, people think of cash. Cash flow the term comes from educating it’s a cash flow risk, but it’s basically your forecasted risk. So if you’re sitting here today, thinking about six months from now, I’m going to have this transaction, I’ll be able to sell this widget and I will have something to record on my accounting books. That’s that period from today. In our example, it looks like it’s four months, but it’s that forecasted period between now and then there are no, there’s really no financial impact.
When things you know, six months on the road, when that transaction actually happens when you sell that widget, you’re going to have to record something and then what you recorded that is going to be different than what it is today. So it’s that forecasting risk. And that’s what you can apply hedge accounting. Past that, once you’ve recorded their revenue, and the corresponding receivable, both are on your financial statements, now, the receivable is going to get re-measured, and that’s what’s going to cause your balance sheet risk that’s what we say it. The balance sheet risk is where most companies start hedging because it tends to be shorter duration tends to be there’s less forecasting or complexity involved. Margin risk tends to tend to happen once you’ve already had a program in place if you’ve generally comfortable with the concept hedging because there’s more forecasting science or art coming into play. Not a big concern.
This is looking at a sample case study. We are looking at the risk of a company that’s trying to identify and drill down what is really causing this company. They said what 60 million is by unhedged risk to EBITDA, I want to focus on the top three or anything that brings me down to at least 30 million. So when you look at EUR, CAD, GBP, that pretty much brings it down. Past that you’ve got a bunch of currencies. Egyptian pound, very hard to hedge, so not a concern. Keep going down there is Israeli shekel JPY. The other ones may be simpler, but will not work spending the time forecasting not spending time going out there in the market to hedge. So it’s knowing that decision. And then finally, it’s communicating back to our story and Maui and Moana have done well the comeback. And it’s really taking control of the narrative. So they come back and they spread the story in good length. So when you think about communication A strategy, it’s thinking through, who’s my audience? What do they care most about, and then how I accomplished what I set out to accomplished.
[29:12] Siddharth Basu:
And knowing well, that what you report to your treasurer, your Treasury managers are going to look very different than what you report your CFO and then what you report to the board. And then what you eventually report to the street. So it’s having that vision, that dynamic insight into the right level, according to what they’re asking your treasure treasure treasure manages the last level of detail. If you go and pass that CFO level, let me ask for the overarching picture What’s going on? Why? And then when you go into the street, it’s more futuristic. How have we managed what we are already communicated? And how are we gonna manage in the future? So it’s controlling the narrative is really important. And a lot of companies use dashboards, this sophisticated tools, where you can utilize your hedges and your exposures to come up with the story that you want to share again, has to be a true story, but shedding light on what’s really what you’ve accomplished, rather what you feel. If you feel a few things, it’s knowing the why.
[30:09] Siddharth Basu:
So that’s a framework. We’ve got probably five more minutes questions or things you’re dealing with as you’re doing your epics program or interest rates.
[30:21] Siddharth Basu:
How many of you are hedging right now? using anything? No hedging. Okay, well, if you know if this helps, certainly use this, give us a call. Hedging is a complicated topic. But most people think of derivatives as Warren Buffett would say, as a weapon to play financial mass destruction. Don’t think of that. There are simple things that even your banks can tell you how they work. It’s obviously knowing there are no free lunches somewhere out what is that trick that you manage? Well, thank you very much.
Its already started.
[31:00] Siddharth Basu:
Too bad. I’m sorry for holding you back.
[0:00] Anchor: Thank you for joining today’s session on risk management and hedging across the internet and FX. We have today with us. Siddharth Basu, director, Treasury advisor, an advisory from Chatham financial. So there’s a signboard being circulated. Please make sure you have your name and email addresses on them. It will help us to give you the presentation slides through email and also help you gain one credit for CDP recertification. So Siddharth the stage is all yours. Welcome. [0:36] Siddharth Basu: Thank you again for attending. You are the few but, the mighty especially. But I was at 4:15 you know, choosing to learn about derivatives theoretical being at happy hour so fully acknowledge that. So my responsibility for the next 30, 40 minutes is to make sure you have a good time to review up for the happy hour and the dinner. And along with that hopefully, you learned a few things about derivatives something about me, then maybe a Disney movie. Before I get started, I’ll do a brief roll call. How many of you work on hedging or derivatives? Weekly, monthly, according to this or have worked on it before? All right, you guys…
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