How Woord en Daad manages foreign exchange
The previous blog discussed currency risks and strategies to deal with these risks. At the Partos meeting mentioned earlier, Arnold van Willigen presented the Woord en Daad approach.
Woord en Daad’s income is mainly in Euros, so currency risks on the income side are limited. On the other hand, it pays its contracts with partner organizations in local currency which has clear advantages:
- Transparent audit trail. The plan and budget, the contract, the payments, the reports are all in the same local currency, increasing recognition and traceability of the figures throughout the chain.
- Less vulnerability for fraud. Since reports are in the same currency, there can be no fraudulent acts by black-market conversions and exchanges.
Woord en Daad implemented a strategy, whereby the currency profits/losses are compensated through a separate forex risk fund. The basic idea is straightforward: deposit all profits in a fund and withdraw all losses from that same fund. And monitor the balance. In this way, project budgets are not affected by exchange rate differences over which you have no influence, and a partner knows in advance which (local currency) budget can be counted on.
It sounds simple and the principle is simple too. Of course, it’s important to take some factors into account.
In fact, this fund is a sort of self-insurance against currency risks. To maintain and strengthen the fund, a ‘premium’ is charged on project proposals. Therefore, this risk is made very visible and is even part of the negotiations or discussions with back donors. For a number of years, money was added to the forex fund. In recent years, the buffer has been stable; losses and gains balance each other out.
Because Woord en Daad cannot take unlimited currency losses, they always commit to project obligations for a maximum of one year. In this way, the partner always knows for the entire year what will be paid in his (local) currency.
Each month, the realized and unrealized forex results are reported and analyzed in a PowerBI environment. This allows Woord en Daad to continuously monitor the state of the fund to avoid surprises.
Because of this approach, partners do not have to deal with interim adjustments to their annual budget and their annual targets and indicators. It also brings peace of mind to the project, because there is no constant uncertainty (with every payment) about the actual amount to be received.
Woord en Daad has had experience with this fund for some time now. It shows that it is possible to manage risks in this way. In the longer term, large price fluctuations (such as during the credit crisis) are compensated for. It is also seen as a positive side effect that the forex risk is made explicit, also in discussions with back donors.
Are there any warnings? There are, in line with the characteristics mentioned earlier. Because no financial instruments are used to limit the risk, Woord en Daad bears the entire risk. In an unstable market, the amounts involved can quickly increase. That is why a substantial financial buffer as well as close monitoring are essential. Due to the annual adjustments to the commitment, partners in multi-year projects still have a degree of uncertainty about the financing of long-term projects.
Finally, a number of lessons learned:
- Reflect on forex risks and determine strategic starting points (policy);
- Decide what risks you are willing and able to take;
- Include impact risk, as well as financial and fraud risk in the consideration;
- Hedging can be helpful if you can’t offset well between currencies;
- An in-house fund requires a certain financial buffer (appropriate to the exposure) and a basket of various currencies;
- Integrate currency risk into the cost structure of projects;
- Reconsider policies from time to time, but operate consistently when markets are very volatile;
- Make use of external expertise, but also keep it simple;
- Distinguish between inflation risk (which can be budgeted for) and currency risk (which is compensated out of the fund)
- The only bad currency policy is no currency policy.
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