The term VUCA is common to military education, an acronym of Volitility, Uncertainty, Complexity and Ambiguity and has been used for year to assess the likelihood of policy failure, system failure, even whole organsiation failure.
Since COVID19, the need to proactively manage risk is greater than every, particularly cash management and currency risk.
In this article, we set out the background to managing foreign currency uncertainty in business, how FX exposure arises and the type of risks you need to identify.
VUCA in Business
- Volatility: the nature and dynamics of change, and the nature and speed of change forces and change catalysts. Eg: Seismic changes due to a global pandemic.
- Uncertainty: the lack of predictability, the prospects for surprise, and the sense of awareness and understanding of issues and events. Eg: Impact on global and local economies and change in consumer behaviour and supply chain.
- Complexity: the multiplex of forces, the confounding of issues, no cause-and-effect chain and confusion that surrounds organisation. Eg: Multiple pandemic management approaches, Multiple political and scientific forces, multiple stimuli and recovery approaches.
- Ambiguity: the haziness of reality, the potential for misreads, and the mixed meanings of conditions; cause-and-effect confusion. Eg: Understanding of the reality; testing, R rate, different measurement methods and no universal advice on containment or an available vaccine.
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All in all, managing cash and FX risk in our current climate means taking a much more hands on approach, and create a policy approach (formal or informal but we do need an proactive approach).
From an FX point of view, we can manage this VUCA world, by focusing on our objectives and asking a number of questions.
- What are you as a business trying to achieve at this time?
- For example, are you looking to reduce the impact of your FX volatility by a certain amount?
- Are you looking to reduce the impact of foreign exchange volatility on your bottom line or to protect a set budget rate?
- The Policy should also describe what the business is trying to achieve through managing its FX risk.
- Is it to have protection or flexibility or a combination of the two?
To support your objective you should look to clarify the parameters of your FX Policy by asking the following questions:
- How long should you be hedging for?
- Is there any seasonality to your requirements?
- What are your confidence levels in your forecast?
- Can you define the difference between committed and forecasted exposures?
- How much flexibility do you require in your FX Policy?
- Do you want the Policy to have an even level of hedging for the full term or do you want to taper
- the percentage hedging ratio i.e. higher levels of hedging in the near date reducing over time as confidence levels reduce?
Clearly we are in unprecedented times, but we still have an opportunity to manage and reduce risk if we take a proactive approach, start by asking your team these questions and lead your companies FX policy, whether it is formal or informal.
This article was written by John Freeme of XE.
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