Much ado about currencies

Volatility in international currency markets creates headaches for Asia’s treasurers.
The euro-US dollar exchange rate from May 2007 to May 2010.
The euro-US dollar exchange rate from May 2007 to May 2010.

Corporate treasurers like predictability. Stable markets mean cashflow projections for the short- to medium-term hold true and life is less stressful.

Unfortunately, this is not a predictable world.

Today, the gyrating euro-US dollar exchange rate is high on most treasurers' minds. Year-to-date the euro has depreciated against the dollar 14.3% to $1.23 this past Friday -- its lowest point in years -- while a chart of the exchange rate since May 2007 looks just like a cut away of the Rocky Mountains -- all peaks and valleys with very little stability. The value of the euro against the dollar peaked at $1.60 in April 2008.

"[Exchange rate volatility] is a real headache for us," said Ben Ho, Asia-Pacific vice-president of finance and controlling at German consumer goods company Henkel. "We are having phone calls on a daily basis to try to minimise the exposure."  

When exchange rates are predictable, it is easy for treasurers to estimate a company's cross-border payables and receivables and create short-, medium- and long-term liquidity plans. This is especially important in Asia where currency conversion is a must whenever you cross a border. However, when exchange rates are volatile, treasurers face a difficult time formulating an accurate liquidity plan and hedges are tougher to implement because the direction of currency prices is unknown.

Banks and vendors acknowledge the difficulty of foreign exchange by offering numerous products to make the task easier. Deutsche Bank offers treasurers FX4Cash, a tailored solution designed for exchanging cross-border payments, and FXall is an online currency hedging tool popular with treasurers. But no matter how many tools are available, volatile exchange rates create headaches and cost money. 

"Volatility is reflected in higher option premiums and thus has a direct cost impact," said Fabian Boklage, Asia-Pacific regional treasurer for Henkel, who reports to Ho. He would not elaborate on the amount of those direct costs.

The euro-US dollar exchange rate does not look like it will settle down any time soon. "Everybody in the whole world is searching for direction right now," said Peter Lundgreen, founder and chief executive of Danish risk advisory firm Lundgreen's Capital.

He and other experts agree that the market's negative reaction has been overblown, but he said that until there is more clarity on how Europe's sovereign debt issues will be addressed, especially in Italy, Spain and Portugal, the market will continue to be unpredictable.

"The euro as it was imagined has failed," said Lundgreen. "That an EU country would have to be partially bailed out by the IMF [International Monetary Fund] was never expected. The market is now pricing for what might happen in the next two or three years. It's pricing the developments too fast." 

There is at least one positive side to the European situation -- the impact on Asian economies looks as if it will be minimal. "Asia doesn't look likely to dip again -- slow it will, for sure, but don't fear a rerun of those dark days of late 2008," wrote Frederick Neumann, Asia economist at HSBC, in a report. He attributed the positive news to lean inventories abroad, supportive monetary conditions and strong domestic demand in the region.

But the positive economic outlook is of little consolation to treasury teams which, like at Henkel, must manage cross-border payables and receivables. Boklage said the volatility continues to make hedging more "challenging", requiring him and his team to monitor currency and interest rates daily.

"We stay in close communication with our business units on a daily basis to identify the currency exposures and to make the right decisions," he said. "We also do a lot of scenario analysis and modelling, to see and prepare for what would happen in a variety of situations."

While there is no golden ticket to mitigate foreign exchange volatility, there are a few common practices treasurers can take note of to manage it better. "The 'right' programme depends upon a company's unique objectives, cashflows and management approach," said Mark Burrough, Asia-Pacific regional FX product manager at J.P. Morgan treasury services. "Clearly defining the corporate policy with regards to risk management is a first step in developing a hedging strategy."

All treasurers spoken to for this piece had a currency hedging strategy in place prior to the  current period of volatility. What has changed is the amount of attention they are devoting to their respective strategies.

In addition to planning, communication is a top priority. Boklage said he and his team communicate on currency hedges at least once a week, if not more often, and David Foster, Asia-Pacific vice-president of finance at Eaton, stays in close contact with his team around the region, using new media to keep everyone on the same page while he manages the company's nearly $2 billion in annual foreign exchange transactions.

Finally, woe to the treasurer who does not know his/her currency position on a regular basis. Damian Glendinning, treasurer of Lenovo, said that he receives a summary of the company's currency positions on his desk every morning and addresses issues right away -- something that would not be possible without frequent reporting.

Exchange rates are unlikely to stabilise any time soon. In the short-term, Europe's debt problems are likely to weigh on the euro until they are sorted out. Medium-term, China is expected to allow the renminbi to appreciate against the US dollar beginning later this year; a much needed revaluation according to most experts but a headache for treasurers until they know how much and when. Long-term, high debt levels in the US and the overall shift in global economic power to Asia pose questions about the dollar's valuation in the future.

For now, no matter what a treasurer does, the only certainty in today's currency markets seems to be uncertainty. Be prepared.

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