Foreign exchange risk management policy - Department of Treasury ...

Foreign exchange risk
management policy
September 2010
Foreign exchange risk
management policy
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Background
Policy
The objectives of this policy are to ensure that foreign exchange risks are effectively identified, assessed,
monitored and managed by departments and agencies, and that the strategies adopted by departments or
public sector agencies are consistent with the overall objectives of the Government.
The State has a conservative approach to the management of foreign exchange risks and accordingly,
departments and public sector agencies are encouraged to develop specific measures that best address the
foreign exchange risk of their business.
Foreign exchange risk is the risk that the rate of exchange used to convert foreign currency payments and
receipts or assets and liabilities to Australian dollars will move in a direction that causes an adverse impact
on the State’s budget outcome.
Foreign exchange risk may arise from a contractual obligation entered into by a public sector agency to
obtain or supply goods and services or to undertake borrowings or investments in a foreign currency. An
example is the purchase of equipment with payment denominated in a foreign currency.
Foreign exchange risk should be measured on a net basis after taking into account any offsetting or natural
currency exposures.
A public body that has a foreign currency exposure that is in aggregate AUD1,000,000 or more and is known
with certainty (with respect to the timing and quantum) must fully hedge the exposure. Except with the
prior written approval of the Treasurer, a hedging transaction in excess of AUD1,000,000 must be with
Treasury Corporation of Victoria (TCV). A public body should also hedge any exposure below AUD1,000,000
where it is considered material, and known with certainty.
A material exposure is something that can adversely affect the budget outcome due to foreign exchange
movements. ’Known with certainty‘ means that public sector agencies need to be certain about the timing
and amount of the foreign currency payable/receivable before the exposure is covered. Hedging will
eliminate the risk of an adverse budget outcome and achieve certainty.
Immaterial foreign currency exposures such as minor travel costs, will generally not need to be fully hedged
unless deemed to be material in nature. Similarly foreign currency exposures that arise as part of an
approved long term investment strategy where the currency exposure is being managed as part of the total
investment portfolio risk, will also generally not need to be hedged.
All hedging transactions in excess of AUD1,000,000 should be undertaken with TCV in accordance with the
Government’s centralisation policy. Public bodies can undertake hedging transactions with their primary
banking institution where the aggregated exposure is below AUD1,000,000. However, in such instances
they must benchmark any quoted rate against relevant market rates as published in the Australian Financial
Review or a similar reputable source. Also, TCV can advise and consult with departments and public sector
agencies in relation to foreign currency hedging strategies.
Instruments that may be approved for hedging FX exposures are spot and forward foreign exchange
contracts and forward foreign exchange option contracts.
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Operational Guidance
Foreign exchange risks are quantified by identifying all currently held assets and liabilities denominated in
foreign currency and identifying contractually committed future currency transactions. The foreign
exchange exposure will exist until settlement or until the exchange rate is fixed. The foreign exchange
exposure is determined by aggregating these balances by currency and settlement date and converting to
Australian dollars at current exchange rates.
Hedging transactions may only be closed off if a change in foreign currency receipts and payments occurs
and retaining the transaction results in an increase in exposure levels.
Any funding bids that contain currency exposure should address the proposed currency hedging strategy.
Bids should price future foreign currency denominated payments at the relevant forward rate which can be
obtained from TCV. The preferred instrument for hedging identified foreign currency risks identified in
funding bids is a forward foreign exchange contract. An option strategy may be considered in exceptional
circumstances, however will need to be supported by a justifiable business case. In addition, the option
premium costs will need to be included in the funding bid.
Performance Measurement
Performance is measured by the degree to which an agency has reduced its foreign exchange exposure.
Further Inquiries
If you would like further information about Victoria’s Foreign Exchange Risk Management Policy please
contact, James Dennis, Senior Analyst, Financial Risk Management, Department of Treasury and Finance, on
(03) 9651 2313.
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