A hedging policy is not a compliance exercise — it is the single most important document in your treasury governance framework. It tells the board what risks are being managed, how, and within what limits. Yet many mid-market companies either lack one entirely or have a document so vague it provides no practical guidance.
What a hedging policy should contain
A well-constructed policy is typically 8–15 pages and covers the following areas. It should be written plainly enough for a non-specialist board member to understand, and precisely enough to guide day-to-day decision-making.
Objectives
Why does the company hedge? Typical objectives include protecting budget exchange rates, reducing earnings volatility, preserving cash flow certainty for capital expenditure, or managing interest rate exposure on floating-rate debt. The objectives should be specific and measurable.
Scope
Which risks are in scope? FX transaction risk, FX translation risk, interest rate risk, commodity price risk? Define the currencies, tenors, and exposure types covered. Equally important: state what is out of scope.
Permitted instruments
List the instruments the treasury team is authorised to use — for example, forward contracts, vanilla options, collars, or interest rate swaps. Explicitly prohibit anything speculative or exotic unless there is a documented business case approved at board level.
Hedge ratios and limits
Define the minimum and maximum hedge ratios by tenor. For example: 75–100% of exposures in the next 3 months, 50–75% for 3–6 months, 25–50% for 6–12 months. These bands provide flexibility while ensuring a minimum level of protection.
Approval authority
Who can approve hedges at each size threshold? A clear matrix — from the treasurer to the CFO to the board — prevents unauthorised activity and ensures appropriate oversight.
Counterparty policy
Set out the criteria for selecting and monitoring counterparties — minimum credit rating, regulatory status, concentration limits. Review counterparty exposure regularly.
Reporting and review
Define the frequency and content of reporting to the board. At minimum, the board should see a quarterly summary of outstanding hedges, mark-to-market valuations, hedge effectiveness, and any breaches of policy limits.
Excessive complexity (making the policy impractical to follow), insufficient specificity (providing no real guidance), and failure to review and update as the business evolves. A good policy is a living document — reviewed annually and updated whenever the risk profile changes materially.