Managing Asian FX risk

Edoardo Sirtori, regional treasurer Asia for ST Microelectronics, talks about the challenges of managing foreign exchange risk in Asia.
What is the extent of ST MicroelectronicsÆ FX exposures in Asia?
I am responsible for the treasury centre located in Singapore for the Asia region, which includes Asia Pacific, India, Japan as well as Greater China. In terms of foreign exchange we manage transaction risk exposures in currencies other than our functional currency of US dollar amounting to approximately $80-100 million in local currency terms and largely denominated in Singapore dollars, ringgit, renminbi and rupees. To a lesser extent we also have FX risk in Taiwan dollars, Hong Kong dollars, won, yen, euro, Australian dollars, baht, and Philippine pesos, so I would say that we are quite broadly exposed. Economic exposure is managed at the group level and we do not hedge translation risk.

Exposure identification, monitoring, netting and hedging are centralised for the entire region in Singapore. Trading is done for all operating entities either directly or on behalf of those entities that are not allowed from a regulatory and fiscal perspective to transact directly with the treasury centre. Post-hedge reporting such as profit and loss on exchange, mark-to-market of the outstanding positions are also managed out of Singapore for the region.

What are the key challenges ST faces on the FX front in Asia?
The key challenges are largely confined to those markets with foreign exchange restrictions and controls, such as in China and to a certain extent in Taiwan, Malaysia, Korea and India. In these markets all FX trading needs to be done on behalf of counterparties in the respective countries as the currencies are non-convertible. In China the capital, or investment, account is still very restrictive with little flexibility over foreign exchange conversion. On the current, or trade, account there have been improvements in 2006 to ease the administrative burden of FX management, but more still needs to be done. For instance all foreign exchange conversion should match a payment invoice or purchase order and requires prior approval from the foreign exchange bureau. This limits the duration and amount of the coverage. In other jurisdictions, forecasts need to be verified and approved if the intention is to hedge longer-term so as to prevent speculation.

Is there a way of avoiding or, at least, minimising that cost?
To avoid the swap cost of longer dated hedges in renminbi and to better control the profit and loss on exchange against our monthly book rates we have chosen to hedge via the money market rather than the forward market in China. This has worked out nicely for us this year in view of the rapidly appreciating renminbi. We have also been able to better manage the effect of general Asian currency appreciation this year by adjusting our hedge ratios to being 100% covered at all times with minimal short open positions.

What is your approach to managing currency risk outside the regulated markets?
We operate as a cost centre. In other words, most of our FX risk is eliminated once it has been identified and there is limited active risk-taking activity. The company is in the business of manufacturing and selling semiconductors and this remains the core activity of the group û not foreign exchange trading. This is a strong mandate that has been passed down from top management.

That said we are highly centralised in terms of foreign exchange management. There are no authorised dealers in any of the local sites. All dealing is done by my team on a central dealing portal here in Singapore. Similarly, the identification, monitoring, analysis and reporting of exposures are also managed out of the treasury centre in Singapore. In certain regulated markets the usual back-office functions of confirming, settling, paying and accounting are handled by the local controllers, but where feasible it is being moved to Singapore. The objective is not to have anyone at the local sites handling treasury activities and to consolidate the expertise in one organisation.

What do you look for in FX providers?
Of course, pricing is critical, however given that there is no longer, at least in the spot market, an asymmetric information divide between the buy and sell side as used to be the case, not only do we expect pricing to be aggressive, but it must also be consistently competitive over time in various market conditions and even at different times of the day. The ability to execute large trades is usually another differentiating factor separating a good FX bank from one that is just average.

How did the weak US dollar affected you in 2007?
Essentially we are long US dollar throughout the region with operating expenses in several local currencies. Therefore, our decision to be fully hedged throughout the year has paid dividends with the across-the-board depreciation in US dollar against Asian currencies in 2007. Without any significant hedging the main impact would have been on our manufacturing sites in Malaysia, Singapore and China where about 90% of our local currency costs are derived. All these currencies have appreciated approximately 5% versus the US dollar since the beginning of the year.

Was that hedging decision based on an in-house forecast or on advice from an FX provider?
Our decisions are made after considering market research reports from various banks and are largely based on fundamental analysis, but are always an independent decision taken with the approval of group treasury in Geneva.

What is your outlook for the dollar in 2008?
My completely independent view, which does not reflect STÆs position in any way, is that fundamentally the US dollar should continue to fall until the world economy can work out the massive imbalances that currently exist between consumption and production. As the dollar declines these imbalances can be brought back into equilibrium but it will take time.

That said, the US dollar has been falling since 2002 and has overshot against some currencies, hence some reversion is in order, perhaps next year. However, this will also depend on a soft or hard landing scenario in the US, the end of the Fed easing cycle and whether we are still talking about subprime related write downs this time next year.

This story first appeared in a foreign exchange supplement that was published with the December/January issue of FinanceAsia.
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