Bearing Industry - How Can You Save 2% by Getting Your Risk Management in Order

• A mid-sized company from the Bearing industry was involved in importing & exporting ball bearings. It had an annual exposure of USD 50 million. The company was a net exporter. 
• The company found its hedging process suboptimal in the wake of extreme volatility (both imports & exports). Gyrations in the currency resulted in operating profits getting eroded by FX losses.

Challenge and Observation

Conservative policy of the company forbade the team from executing swift decisions in volatile markets. As a result, the company was bearing the brunt of FX losses.

Observation: 

• Inefficient systems used for managing FX exposures (lack of hedging instruments and trade finance products, and inefficient business processes). 
• No risk management policy in place which would articulate the hedging mechanism under various circumstances. Hedging decisions were therefore quite random and based on instincts. 
• Decisions were made only by the top management which resulted in the hedging process being less agile and dynamic.

Process

• A Risk Management Policy was framed after studying the company’s business cycle and cash flow process and after interacting with the senior management to gauge the ability and willingness of the company to take risk. The policy focused on streamlining the cash flow process by using the right kind of funding tools and by implementing an effective hedging strategy to reduce currency risk. 
• The company was advised to inculcate the practice of natural hedging to the extent possible (Import-Export Set off). For excess exports, the company was offered a comprehensive strategy to make the most of market opportunities. 
• IFA advised on various short term and long-term funding alternatives available to reduce the interest cost and criteria for when to borrow in foreign currency and when to borrow in INR. Benchmark Cost of the company for its products was reworked, taking the hedging cost and the competitiveness into consideration. A systematic hedging process helped the client make its costing more competitive, thereby helping it garner more business. 
• Roles and responsibilities of treasury functions were defined to facilitate timely action. 
• The policy required the company to maintain a certain Dynamic Hedge ratio, which could be systematically increased or decreased only during quarterly reviews. A limit was set up for maximum unhedged exposure/open exposure at any point of time with stop loss being the benchmark cost. This ensured that the operating profit was not under any circumstance eroded by FX losses. Instrument wise ranges were set for hedging. i.e. what percentage of exposure to hedge through forwards, through vanilla options, through RRs and so on.

Outcome

• The company was able to manage its exposures more effectively with a well-articulated Risk Management Policy. 
• Since the policy laid down systematic hedging processes, speculations in forex took a back seat. 
• A well-guided infusion of credit in a structured manner helped reduce the interest cost. 
• Realisations through FX improved by Rs 7 crores, thus improving the PAT margin by 2% of the revenue. 
• It helped set up an efficient banking system and utilize idle funds in a systematic manner.