HedgingDecisions
RiskDimensions&Stakeholders
Table1: RiskDimensionsinaHedgingProgramme
The decision to hedge should be approached
carefullyandmethodically.Hedgingdecisionsare
RiskDimension KeyConsiderations
often complex and management needs to
recognise in advance that a multi-disciplinary
Hedging Philosophy Ensurekeystakeholdersobjectives,benchmarksand
approachisrequired.Table1outlinessomeofthe
risk appetite clearly defined and balanced. Possible
improvementincostofcapitalandcreditrating.
keydimensionsthatneedtobeconsideredatthe
timeofmakingahedgingdecision.Inaddition,
Programme Horizon How far do we want to fix the price component of
adequate quantitative support needs to be
revenuesandcostsintothefuture?Maybeafunction
availabletoanalysealternativestrategies,acquire of other variables such as hedge effectiveness
market information, network with potential considerationsandliquiditypositionofthefirm.
counterparties,andrunscenariomodelstoensure
thatriskandreturntradeoffsarewellunderstood.
Hedging What are the instruments allowed? Basis risk
Quantitative considerations must be balanced
Instruments tolerance?Whatisthebudgetavailabletopurchase
by such ‘soft’ sciences as behavioural finance,
hedginginstrumentsand/orinsurance?
whichcanhelpidentifypitfallsthatarecommon
to many human decisions. An in-depth
Hedge Volumes Target percentage of expected costs/revenues to be
hedgedfordifferenthorizons.
understandingoftherolesofregretandhindsightin
hedgingisalsonecessarytoensurethelong-term
Cash Flows Potentialmarginrequirements(initialandongoing);
viabilityofahedgingprogramme.
MtMconsiderations;cashtopurchaseoptions;
TheElephantintheRoom: Accounting & Increaseddisclosuresinfinancialstatements(e.g.FAS
Hedger’sRegret Reporting
161); valuation of derivatives (e.g. FAS 157); hedge
The only iron clad certainty with a hedging
effectivenessconsiderations(e.g.IAS39;FAS133).
programme – or the lack of one – is that some
stakeholders will be unhappy with the outcome.
Credit Rating Consistenthedgingpolicymayhelprating.Important
Whenhedgetransactionsshowaprofit,someone
to evaluate impact of various outcomes of hedging
will want to know why you did not do more
programmeincreditratingandliquidityofthefirm.
volume. If transactions show a loss, another
Risk Management Risk management process to ensure hedging
personwillwanttoknowwhyyoudidnottimethe
programmemeetsobjectives.Policies,methodologies
marketbetter.
andinfrastructure.Internalcontrolchanges.
Thissomewhatirrational‘lookbackrisk’canbe
quantifiedas‘hedger’sregret’,whichissimplythe
difference between the price achieved under a
Source:BlackSwanRiskAdvisorsLLC.
hedgeprogrammeandwhatanunhedgedstrategywouldhave to ensure that debt is serviced, while shareholders may not
producedandcanbeeasilymodelledandincorporatedintothe wanttolimitupsidepotential.Itistheboard’sresponsibilityto
decisionmakingframework reconcile these competing interests by establishing a sound
Many hedging programmes fail to properly address and hedgingpolicy.
manageregretrisk.TakethepoorriskmanagerorCFOwho Successful hedging programmes draw a clear distinction
lockedin2009gasoroilpricesinthesummerof2008athigh betweenthequalityofthehedgingdecisionandtheresults
levels. Current deliveries are now priced at more than 40% of the hedging programme in a given period. Part of the
above the market. A properly designed hedge strategy that hedging strategy formulation therefore involves the
addressed regret risk could have included an inexpensive selectionofabenchmarktoevaluatetheeffectivenessofthe
optiontrade,andsignificantlylimitedthehedgingloss. hedgingdecision.
In addition, different stakeholders such as management, Management and boards should accept the fact that no
creditorsandemployeesmayhaveconflictingviewsintermsof one in their organisation will be able to profitably and
theultimategoalofthehedgingprogramme.Managementis consistently forecast the direction of commodity prices,
ofteneagertolockingains(andbonuses),bondholderswant includingthemselves.
worldPower2009 45
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