The soaring U.S. dollar and weakening foreign economies are hurting American multinationals’ earnings, treasurers tell AFP. Firms coughed up $8 billion in currency losses in Q3 2014 alone, according to FiREapps. Meanwhile, the Wall Street Journal Dollar Index, which tracks the USD against the euro, Japanese yen, British pound and 13 other currencies, has climbed more than 7.5 percent this month alone, nearly hitting a 12-month high. In 2014
“There are two playing fields here: transaction and translation,” said the treasurer of a global retailer. “If I have operations outside the United States in functional currencies that are doing very well, there may be zero transactional exposure. Those entities buy, manufacture and sell locally. Even though they do well, their results translate into a less positive number. That’s one where it really puts a lot of pressure on companies to explain translation. It’s not an economic impact; we’re not making less money. It’s an accounting concept.”
The treasurer added that translation only matters for companies with an active repatriation program and who plan to turn those local profits into cash or dividends.
The other threat: Transaction exposure
According to the global retail treasurer, the other challenge is transaction exposure. That means local entities buying in U.S. dollars, which raises their cost base when selling those items locally. “That’s when it’s really important to make sure that you have a really solid forecast,” he said. “And that’s when you look to hedge out for as long—and as much—as you can to achieve that certainly. The soaring dollars puts more pressure on the forecasting and planning functions, so it’s important to get a better view of that cash flow exposure and protect it early on in the process.”
The treasurer’s company hedges out a year in a combination of straight hedges and a layered approach. The duration of the hedge depends on your business cycle, he explained. The layering approach is used primarily because of the potential variability in the forecast. “The question is, what variability do we have in the forecast, or what certainty do I have with a number that’s 12 months from now,” he said. “We hedge some confidence level, as I get close to that, hedge more.”
Steps toward an effective hedging program:
- Collect accurate exposure information—as long-range as possible. As currencies and other commodity prices become more volatile, exposure data becomes more important. Work with subsidiaries to create a process where treasury receives early warning about new risks.
- Conduct exposure analytics/evaluation. Trying to pull both layers of information together, settling on a net number, and devising a strategy that will reduce the FX-triggered volatility is the next big job. Even if treasury gets all the right data, making sense of it often requires advanced technologies, which treasuries lack. Analyses like cash-flow-at-risk are increasingly common. Those can be accessed as a service on an outsourced basis.
- Match hedge duration to the business cycle. Some companies can only look out one year, but others with longer production cycles, like automakers, can hedge further out—perhaps three years. The important thing is to use the hedge program to provide the business with some predictability of outcome.
- Lastly, measure performance separate from accounting effectiveness. It’s hard to measure FX performance because many treasuries lack effective performance measures. That exposes them to second guessing and criticism from management. Effective metrics link objectives to results. Common, simplistic measures compare the hedging program to a no-hedge or 100 percent hedged portfolio. But such measures fail to capture the nuances of hedge programs.
Conclusion: Keep it dynamic
Experts suggest lengthening hedge duration or using more layered strategies in light of recent events. “A lot of hedge programs are stagnant,” said Helen Kane, president of Hedge Trackers LLC. “A lot changes. The business changes, the market changes. Treasury needs to get out of the ivory tower and understand how the business works. This has become increasingly important as the currency and economic environment have shifted. What worked last year or even over the last decade may no longer be effective.”For more FX guidance, click here.