How to Implement Internal Controls for FX Risk Management

Internal control (IC) involves everything that controls risks to an organization. IC relates to operational effectiveness and efficiency, reliable financial reporting, and compliance with laws, regulations and policies. When it comes to hedging foreign exchange risk and Sarbanes-Oxley (SOX), management should be able to understand, assess, and conclude on the adequacy of internal controls over financial reporting as it relates to currency risk management.

In general, a minimum of three personnel are required for sufficient internal controls since the trading, accounting, and confirmation duties should be segregated. For example, the Chief Financial Officer (CFO) could be responsible for confirmation and authorization, the controller could be responsible for accounting and record keeping, the treasurer could be responsible for trading and custody. Furthermore, the Board of Directors could be responsible for oversight and approval, and in the event that an exception to the Policy is warranted, the CFO could be responsible for approving any exceptions.

While specific internal controls will need to be tailored to the specific needs of an organization, some key questions that should be addressed include:

1. Who has the authority to execute trades?
2. How will trades be executed and what process should be followed?
3. How and when are trades confirmed and compared?
4. Are the trading, accounting, and confirmation duties segregated sufficiently?
5. Who has the authority to authorize policy exceptions, and trade ticket or accounting discrepancies?

It is critical to include internal controls as an essential component of an effective Foreign Exchange Risk Management Policy because it outlines in detail the specific processes to be followed. The Internal Controls section of a Policy should address the key questions above by stating internal controls have been set forth to segregate the trading, accounting, and confirmation processes. Continuing the example using the CFO, controller, and treasurer, internal controls could apply to the following FX Risk Management related tasks:

• The Treasurer will be responsible for recommending hedging strategies, and the Controller and Chief Financial Officer will be responsible for approving the proposed strategies prior to trade execution.
• The Treasurer will be responsible for selecting counterparty foreign exchange service providers in accordance with 'Counterparty Guidelines', and the Controller is responsible for approving the selected counterparty prior to trade execution.
• The Treasurer is responsible for executing approved hedging strategies and subsequently recording the transaction in the appropriate general ledger account within 24 hours. The Controller is responsible for confirming that the financial reporting surrounding trade execution matches the trade confirmation received by the counterparty service provider within 72 hours. If a trade confirmation is not received within 72 hours, the Controller is responsible for obtaining the confirmation directly from the counterparty service provider, mediating any disputes between the Treasurer and the counterparty service provider, and alerting the Chief Financial Officer of any pertinent issues.
• The Treasurer will prepare a cash reconciliation at each month end related to all underlying positions and derivative transactions, both inflows and outflows, that occurred throughout the period. The Controller will cross check the cash reconciliation with all trade confirmations to ensure cash balances reflected on the accounting records match the economics of the underlying positions and derivative transactions settled throughout the period.

These are just some of the many ways organizations engaged in foreign exchange risk management should be considering internal controls as part of their currency hedging program and formal Policy. Keep in mind that policies and procedures are never perfect, and should be viewed as a process that is responsive to change and capable of continuous enhancement. By starting sooner rather than later, practice, experience, and results will contribute better information to the internal control process allowing for changes to be made to the foreign exchange risk management program in the future.

If you are interested in learning how internal controls are integrated into a foreign exchange risk management policy, FX Initiative's currency risk management training has a course on FX Risk Management that walks you through a real-world scenario using the Foreign Exchange Risk Policy Drafter to illustrate step-by-step the process of segregation of duties and how it relates to personnel and reporting. World class organizations know that proactive prevention is the best approach to long-term compliance and sustainability, so take the FX Initiative and improve your internal control process by subscribing today!

Ready to learn about Internal Control and FX Risk Management? Click here to get started >

Cheers,

The FX Initiative Team
support@fxinitiative.com