The snowy days seem catch motorists off guard year after year here in the north. Bizarrely, the same seems to happen to companies with currency risks. Let’s get real: neither should be a surprise.
I recently read in the papers how the CEO of a multinational corporation explained away the weak results of the company with surprising exchange rate losses due to the strength of the Euro compared to US Dollars. I happen to know that the Treasury team of this particular company is highly professional and they have the latest and greatest systems for managing financing risks. So the surprising exchange rate losses most likely did not come from lack of professionalism or lack of technology.
This company is not alone in wresting with currency risk management. Nothing really seems to have changed in this respect in the 20 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 cause of the trouble should be easy to track: it must be something with the business units. The treasury can only act on the information they receive about business risks. The problems are almost exclusively caused by insufficient communication. This is manifested by:
- The business units and the treasury understanding 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 being created only when a currency-based invoice is sent or a supplier invoices 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, the 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.
In my earlier entry Guerilla Treasurer Mindset; Part 3, I gave an example of a business unit that was being lead royally astray because there was no understanding of when a currency exposure is really created.
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 really wants to get something done, just offering advise 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.
In the late 90’s, I was visiting a business unit on the East Coast of the US. This particular unit had not only US operations, but also 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 USD as the business unit had not made a single hedge. During the discussions it became evident that the trading was done in DEM. 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 Deutschmarks, 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 is something is crystal clear to the Treasury, it might not be so to the business units. Since it is the responsbility of the Treasury to manage company-wide currency risks, the Treasury must make sure all links in the chain understand what the this is about.