Karen Horcher

Date: March 4, 2017

Name: CPABC – 2017 Reward and Risk – A Primer

Presenter: Karen Horcher

Successful entrepreneurs who work oversea use hedging and derivatives effectively. Moreover, their strategies reflect on the impact from current financial market and risks. The Chartered Professional Accountants of British Columbia (CPABC) Surrey Chapter invites Karen Horcher, the Treasury Consultant from Hedge Rho Management Inc, to discuss her perspective on hedging and derivatives. Karen Horcher will help entrepreneurs to understand risk, set strategy, and implement right approach. In addition, entrepreneurs will also learn some of essential changes affecting financial markets and risk.

Karen Horcher is the Treasury Consultant from Hedge Rho Management Inc. She holds two designations: Chartered Professional Accountant, and Chartered Financial Analyst. Karen Horcher was a member of Board of Directors for Pacific Pilotage Authority for over 9 years. She is currently one of the advisory board members in CPA Canada. Moreover, she published “Essentials of Financial Risk Management”, “Essentials of Managing Treasury”, and “Practical Guide to Managing Foreign Exchange Risk”.

Hedging and Derivatives

In any business, entrepreneurs must remember that no consultant knows better than them. They are obligated to understand their own risks. Risks come from external and internal. External comes from global market, sales, competitors, inputs, regulatory environment, brand, reputation, and size. Internal includes people, system, processes, pricing, products, projects and other.

Business is like a portfolio of other businesses. It is important to think about what potential ways their customers might go somewhere else. Competitors can drive what entrepreneurs do, especially when competitors can change price easily. Attending Accounting and Sales conference is suggested by Horcher because accounting drives money and sales drives opportunity. Horcher suggests whenever founders or potential decision makers retire, usually systems will change and entrepreneurs should anticipate new risks.

Horcher indicates financial risks make up of market risks, credit risks, and operational risks. Market risks includes interest risks, exchange rate, commodities, and equities. Credit risks come from industry, sovereign, and counterparty. Operational risks come from systems, people and process.

When it comes to risk, entrepreneurs need to think about if it is a part of core business, accident or purpose. The risk can be affected on customers, sales and market share. It is important to know if there is ability to shift risk on other stakeholders, especially competitors.

“Run your business as core, speculate with other”

Entrepreneurs need to consider the risk culture. Every organization is unique, and risks can be developed from ownership, structure, historical or circumstantial. The main questions entrepreneurs need to ask themselves.

1. Do we have confidence in our forecast?
2. How much are we willing to lose?

Most important, Horcher believes entrepreneurs need to know how their business think and how the business manage risk.

Should entrepreneurs hedge? It depends on many factors. Factors include the confidence in forecast, market view, risk tolerance, opportunity loss, the cost of hedging and competitive considerations. Entrepreneurs might already have nature hedge in their businesses. To deal with exchange rate, Horcher recommends entrepreneurs to develop their own market view. They can ask others for research and they will be amazed on how much they already know. When there is opportunity loss, it does not mean entrepreneurs make the wrong decision. Therefore, entrepreneurs can choose not to hedge, business hedge with minimize exposure, hedge using derivatives, or combination of approach. Statistically, successful business will hedge depending on forecast. Based on average, business only hedge 50-70%.

Entrepreneurs can create policies because policies provide framework. This will create a good foundation for procedure and controls. It also facilities measurement and reporting. It has a clear mandate to avoid judging with hindsight. If entrepreneurs want to forecast exchange rate, Horcher suggests them to ask economist. However, forecast is never prefect.

Implementing the right approach can be difficult for entrepreneurs. They can use forward-type derivatives. Forward type includes forwards, future, forward rate agreements, and swaps. The key is that forward type uses fix rate and there is no cost to enter. All parties are obligated to act on the agreement, and forward type do provide some certainty.

Another approach is using options. Options include puts, calls, collars, caps, floors, swaptions, structured, and exotics. It works like an insurance model, which means buyers purchase premium, sellers sell premium, and both are obligated to deliver. Typically, the premium is the sunk cost. Only the seller is obligated to exercise the option.

Entrepreneurs can use derivatives to absorb risks internally. The economic exposure has low margin. It alters process, and it changes the way they do things. Another method is to shift risk to customers. Horcher suggests entrepreneurs to invoice in Canadian dollar. They can develop new source of currency to pay for inputs, or look at their pricing for other differentiations or rate adjustments. They can also shift risk to vendors by paying in another currency or us fixed-price or long-term contracts. Entrepreneurs need to know their exposure. They need to know if it is freely-traded, derivative availability, and market intelligence. Horcher wants entrepreneurs to watch out for over hedging.

Recent change affect financial markets

Horcher provides some major updates that affect financial markets.

Based on G-20 Pittsburgh statement, there were 21 specific recommendations on Over the Counter (OTC). These recommendations include derivative standardization, exchange electronic trading policy, trade reporting and central counterparty clearing.

For trade reporting, it is mandatory depending on province. The reporting excludes any spot foreign exchange transactions within 2 days, commodities, and exchange traded derivatives. The legal entity identifier, DTCC, and CME are established under trade reporting. Entrepreneurs can check British Columbia Securities Commission website for reporting requirement.

Traditionally, OTC derivatives accept bilateral clearing as direct settlement. Now, it is required to use central clearing. Central clearing takes swaps, fixed income, repo, future, options, and currencies to one destination. It is net one payment per currency per day. It is oversight by securities regular or central bank.

There is now an official international reserve. This holds in exchange fund account for GoC. It includes SDR, IMP reserve position, and gold. However, Canada had sold a majority of gold in 2003 and melt the rest. In 2016, there were only 77 ounces left. Canada did not reserve gold because gold is too expense to hold.

The Buffett’s big bet is still on going. Warren Buffet believes high fees will doom hedge funds. Fees come from annual fee, performance fee, active trading cost, and other fund hedge costs. There is new bond reporting requirement. Entrepreneurs can visit Investment Industry Regulatory Organization of Canada for detail.

Horcher wants entrepreneurs to remember the lesson on the 1987 crash. Entrepreneurs should be aware not to let history rerun itself again.