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Navigating volatility in global markets

Authors

  • Zach Goodman

    Partner, Financial Accounting and Advisory Services, Ernst & Young LLP

  • Joseph Soviero

    Managing Director, Financial Accounting Advisory Services, Ernst & Young LLP

  • Michael Barrett

    Partner, FAAS – Commodities, Ernst & Young LLP

7 minute read 06 Mar 2025
Related topics
Financial accounting advisory services

Addressing market volatility is a complex endeavor that requires a strategic approach to risk management.

In brief

  • Global markets have been impacted by high levels of volatility in recent years, underscoring the need for a strategic process that reduces enterprise risk. 
  • Approaches to managing risk include financial derivatives and the application of hedge accounting, but each comes with its own complexities.
  • Dedicated in-house or third-party solutions can enhance decision-making and financial performance.

The increasing volatility in global markets that has marked the economic landscape in recent years presents significant challenges for entities. While underlying market risks often stem from factors beyond a company’s control, they can impact financial performance and operational stability. For instance, earnings volatility can impact financial metrics, stock prices and borrowing costs. Effective hedging programs can help reduce the variability in financial performance and cash flows, which can help maintain investor confidence through more consistent and predictable results. By mitigating exposures and leveraging risk management strategies, companies can more effectively navigate these uncertainties and even thrive in a turbulent market.

Key factors contributing to volatility

Entities have been grappling with volatility on several fronts. Interest rate fluctuations, which affect borrowing costs, investment returns and financial instrument valuations, are a prime example. The US’s secured overnight financing rate (SOFR), for instance, has historically averaged 2.3% but reached an all-time high of 5.4% in January and July 2024.1 The rapid rise in interest rates led to lower fixed asset valuations, as evidenced by financial statements indicating high unrealized losses in available-for-sale (AFS) securities held by entities. As interest rate cuts are expected to continue in the US, entities could also be grappling with volatility in fixed asset valuations throughout 2025.

Entities that operate in foreign jurisdictions or make foreign-denominated transactions also have been facing headwinds. The overall trend of a strengthening US dollar against other currencies affects the value of overseas earnings and has impacts beyond a company’s financial statements. Economic exposures can include future purchases of raw materials or sales of goods in a foreign currency, contracts with foreign currency exchange bands or price adjustment mechanisms, or even simply foreign-denominated investments or debt instruments.

The rising price of certain commodities adds another layer of complexity. In 2024, copper and gold reached all-time highs.2 Oil prices, which, due to pandemic shelter-in-place measures, dropped below zero for the first time in April 20203, averaged $81 per barrel in 2024.4 These price movements can affect production costs, profit margins and overall financial performance.

In addition to these key market risks, inflation and geopolitical tensions are factors that can further exacerbate market volatility. According to the U.S. Bureau of Labor Statistics, June 2022 marked the highest year-over-year Consumer Price Index increase since 1981, rising 9.1%. Although the EY-Parthenon macroeconomic insights for November 2024 projected a disinflationary trend through early 2025, deregulation, immigration restrictions, and tariffs and tax cuts could fuel inflationary pressures in 2025 and 2026, potentially leading to higher interest rates.

How EY can help

Identifying and mitigating exposures

Companies can leverage volatility to their advantage, achieving cost savings and boosting profitability. However, the uncertainty and risk can also lead to negative outcomes, such as higher costs and lower profit margins. Given that volatility can be either a friend or foe, how should a company develop a balanced approach that manages exposures and capitalizes on opportunities? Companies can face challenges in identifying the risk and then deciding whether to hedge and how much.

 

Often, foreign currency exchange, interest rate and commodity risks can be mitigated by passing along the exposure to customers or through natural offsets. Another approach is to use financial derivatives, which can be effective for risk mitigation but come with their own complexities. For example, despite the intent to reduce volatility and risk, derivatives can lead to increased financial statement volatility, since fair value changes in derivatives are recognized on the balance sheet at fair value with changes recognized through earnings. Entities can choose to apply hedge accounting to qualifying transactions if certain criteria are met. If the derivative doesn’t qualify as a hedging instrument, the other side of the journal entry is income. If the derivative qualifies to apply hedge accounting (i.e., is appropriately designated and remains highly effective as a hedging instrument), the remainder of the journal entry depends on whether the derivative is used in a fair value hedge, a cash flow hedge or a hedge of a net investment in a foreign operation. Accounting Standards Codification (ASC) 815, Derivatives and Hedging, of the Financial Accounting Standards Board (FASB), is one of the FASB’s more complex standards; as a result, extensive resources, including system support, may be needed to help entities meet all of its requirements. The FASB has made numerous changes to the standard over the past few years and continues to do so to align hedge accounting with a company’s risk management strategy. In addition, on January 3, 2025, the FASB issued an invitation to comment to solicit stakeholder feedback about the future standard-setting agenda, including around risk management and hedge accounting. This opens the door to potential efforts to simplify, improve and expand the hedge accounting model.

 

Once the risks have been identified and a strategy established, entities need to determine which derivative products are right for them. Types of financial derivatives in the three key risk areas include:

 

  • Interest rate: swaps, caps, floors, collars and swaptions
  • Foreign exchange: FX forwards, options and cross-currency swaps
  • Commodities: futures, swaps and options

By providing a more accurate reflection of the company’s risk management activities, hedge accounting can help manage the volatility in financial statements that financial derivatives can produce. However, hedge accounting is subject to complicated rules. To determine whether to apply it, companies should consider the following questions:

 

  • How clear is your understanding of your company’s exposure risks, and is your risk management policy robust enough to tackle those risks?
  • How is your organization managing volatility in earnings through a hedging program?
  • Do your resources have the capacity for analysis and value-added analytical reporting after time spent performing manual data processes, compliance exercises and valuations?
  • Do you understand the risks to the business from the hedging program and have access to the reports you need?
  • How scalable, automated and efficient are your current process and operations related to the use of derivatives?
  • Do you apply hedge accounting? If not, do you have the resources to tackle the compliance activities required?

The answers to these questions can help companies develop a nimble strategic approach that mitigates exposures and creates the flexibility to pursue opportunities.

Designing a strategy for volatility

With no one-size-fits-all solution for managing volatility risk, companies can choose to either hedge or retain natural exposures created by operations. For instance, a financial institution with one-year liabilities and shorter-term assets might retain exposure to interest rate variability if it anticipates rate increases, which could lead to increased returns on variable-rate assets. Another option is to introduce an exposure on the liability by using derivatives, such as entering into a pay-fixed and receive-floating interest rate swap to mimic floating-rate assets. In yet another example, an entity with foreign currency exposures, anticipating that a foreign currency will lose value against the US dollar, could enter into a forward transaction — a financial contract between two parties to exchange a specified amount of one currency for another at a predetermined exchange rate on a future date.

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The use of financial derivatives introduces additional operational complexities that companies may need to effectively manage over the lifecycle. First, trade decisioning involves determining which trades to execute. Next, trade execution entails carrying out the derivative transaction with a counterparty and obtaining best pricing. Following this, trade capture involves recording the terms of the derivative in the system of record. Confirmation and affirmation then require verifying the trade terms with the counterparty. Settlements and reconciliations address cash movements and the reconciliation of fair values and cash amounts. Collateral management focuses on margin management. Additionally, accounting and hedge accounting are essential for accurate financial tracking. Finally, financial reporting requires that all derivative activities are transparently and completely communicated in financial statements.

To manage volatility risks effectively, companies can either build an in-house solution, implement a third-party solution or choose a hybrid solution for different aspects of the derivative trade lifecycle. The proper support should address the following areas:

  • Ongoing hedge accounting and derivatives valuation that is scalable and flexible
  • Analytics support for hedging, procurement and trading activities, along with hedge performance measurement
  • Risk management insights into hedge performance, portfolio exposure and market risk sensitivities
  • Evaluation of peers, competitors and industry disclosures to generate an understanding of the expected impact on financial reporting and to provide valuable benchmarks
  • Training and other ad hoc support to equip teams to manage risks and implement effective hedging strategies
  • Operational activities around the usage of derivative instruments (from trade decisioning to reporting) as summarized above

Even if companies opt not to apply hedge accounting, they still need the operational capabilities to address the trade lifecycle. Having a dedicated in-house or third-party solution can help navigate the complexities and determine the most effective strategies.

Conclusion

By identifying and mitigating exposures and implementing a strategic approach that builds in the right supports, companies can better manage risk from volatility and protect their financial performance.

Dan Camp, Senior Manager, Financial Accounting Advisory Services, Ernst & Young LLP, contributed to this article.


Summary

Global market volatility creates significant challenges for companies, impacting financial performance and operational stability. Key factors include fluctuating interest rates, foreign currency headwinds and rising commodity prices. Effective risk management strategies, such as using financial derivatives and applying hedge accounting, can help mitigate these risks. Developing a strategic approach, whether in-house or through third-party solutions, can enhance decision-making and flexibility.

About this article

Authors

  • Zach Goodman
    Partner, Financial Accounting and Advisory Services, Ernst & Young LLP
  • Joseph Soviero
    Managing Director, Financial Accounting Advisory Services, Ernst & Young LLP
  • Michael Barrett
    Partner, FAAS – Commodities, Ernst & Young LLP
Related topics
Financial accounting advisory services

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