The first snow seems to catch motorists off guard year after year here in the north. Bizarrely, the same seems to happen to companies facing fluctuating currency rates. Let’s get real: neither should be a surprise.
It is not uncommon for multinational corporations to explain away the weak results partly with surprising exchange rate losses, for instance caused by the weakening of SEK or GBP against EUR. The changes in currency exchange rates should, however, hardly come as a surprise; treasuries are mostly staffed with highly professional people, supported by technical solutions and processes that efficiently help them control risk.
Nothing seems to have changed in this respect in the last 25 odd years, I have been closely following the currency markets: currency risks still seem to surprise companies.
If the Treasury is professionally managed and the systems are working, the source of the problem should be easy to track: it must relate to the business units. The treasury can only act on the information they receive about business risks. Problems are almost exclusively caused by insufficient communication. This is manifested by:
- The business units and the treasury understanding of currency risks differently
- The business units not recognizing their currency exposures
Understanding the Risks
As daft as it may sound, accounting can sometimes prevent functioning currency risk management. Without sufficient instructions and control, the business units easily see currency risks as accounting-based, i.e., the exposures arising only when a currency-based invoice is sent or a supplier invoices them for a currency-based purchase.
If a company has defined that a currency exposure to be covered is created already at the pricing stage of products, hedging should be based on sales budgets. If a business unit construes the exposure to be created only at the invoicing stage, we have all the required ingredients for surprising currency risks.
Recognizing the Risks
During my Treasury career, I often visited the business units to discuss currency risks and consult the business units about managing them. During this time, I learned that if one wants to get something done, just offering advice is not enough: one must also listen to the other side. Only by listening can the Treasury create instructions that business units are guaranteed to understand.
One visit made a huge impact on me. It was with a business unit on the East Coast of the US. In addition to their domestic business, they had some exports to Germany. These exports created yearly roughly USD 20 million worth of currency flow. I had been lecturing to the CFO of the business unit about our corporate policy of avoiding currency risks. He was nodding and assuring me everything was in order.
I had assumed that the underlying currency in the export deals was $, as the business unit had not made a single hedge. During the discussions, it became evident that the trading was done in €. When I asked why the unit had not hedged its exposures, the response I got was memorable:
”We don’t have any exposures. When our German customers pay the invoices in Euros, our bank automatically exchanges them into Dollars.”
After I recovered from my initial shock, we analyzed the situation thoroughly, and the business unit then started systematic currency exposure hedging.
One needs to remember that even if something is crystal clear to the Treasury, it might not be so to the business units. Since it is the responsibility of the Treasury to manage company-wide currency risks, the Treasury must make sure all links in the chain understand what this is about.