Geopolitical Uncertainty Drives 60% of Companies to Extend FX Hedging

In the ever-shifting landscape of global markets, geopolitical risks have become the new normal. The recent surge in geopolitical tensions, from the ongoing conflict in Ukraine to the escalating unrest in the Middle East, has left companies scrambling to protect their financial interests. According to a recent survey, over 60% of companies are now hedging their foreign exchange (FX) risks for extended periods, a stark contrast to the pre-pandemic era when such strategies were seen as overkill.

The current geopolitical climate is a perfect storm of uncertainty. The Russia-Ukraine conflict, for instance, has disrupted energy markets, leading to a surge in oil and gas prices. This, in turn, has contributed to overall inflationary pressures, making it difficult for companies to predict their future costs. The conflict has also influenced other commodities, such as wheat and corn, leading to concerns about food security and pushing up prices for these essential commodities.



Given these uncertainties, companies are turning to FX hedging as a way to mitigate the risks. FX hedging involves using financial instruments to counteract potential losses from rate changes. This is done to lower the risk of fluctuating FX rates. For instance, companies create a forward contract with an investment dealer to sell off currency at a future date at today’s FX rate. This helps in securing a fixed exchange rate in advance, shielding them from unexpected fluctuations.

One of the key strategies mentioned is the use of structured notes, which can express a variety of views, generating income in more rangebound markets, embedding downside protection, or for the bulls, even capturing upside (or leveraged upside). For instance, the VIX, a measure of volatility for the S&P 500, is up 46% in the last 4 weeks and sitting at its highest since October. Structured products can help in generating income while also building in protection against oil price volatility.

The effectiveness of these strategies can be seen in the context of the Russia–Ukraine conflict, which has had a negative effect on foreign exchange rates. The adverse effect of geopolitical risks is more pronounced in countries with high reliance on Russian energy, countries with a high level of economic policy uncertainty, countries with geographic proximity to Russia and Ukraine, and countries where the degree of political rights, and freedom of political expression is elevated. This indicates that companies in these regions have been more proactive in employing hedging strategies to mitigate the impacts of geopolitical uncertainties.

However, the integration of geopolitical analysis into business operations has been recommended as a proactive approach to mitigate risks. For instance, a recent article by Willis Towers Watson on Singapore boardrooms called for a general move from talk to action, starting with an incorporation of geopolitical risk into the mandates of relevant board committees. This includes setting up a dedicated task force or integrating geopolitical analysis into the regular risk assessment process. This proactive approach has been effective in helping companies navigate the increasingly volatile international environment.

In summary, companies are employing strategies such as currency hedging, structured notes, and integrating geopolitical analysis into their operations to mitigate the impacts of geopolitical uncertainties. These strategies have been effective in helping companies navigate the volatile international environment and protect their investments from the adverse effects of geopolitical risks. However, the question remains: is this enough? As geopolitical risks continue to evolve, companies will need to stay one step ahead, constantly adapting their strategies to the changing landscape. The future of global business may well depend on it.