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March 16, 2014 9:07 pm
Two years ago, European businesses were worrying about whether the euro would survive. Today, a bigger problem for many of them is its strength.
With the single currency at its highest level since mid-2011 on a trade-weighted measure, politicians are warning that adverse exchange rates could stall the eurozone’s fragile recovery.
While the euro’s rise against the dollar has been fairly moderate, turmoil in emerging currencies has stung many multinationals – which had bet heavily on growth in emerging economies in recent years to compensate for the lack of activity in their home markets, but now find themselves exposed to swings of as much as 20 per cent between the worst-hit local currencies and the resurgent euro.
“The most obvious [concern for 2014] is volatility in exchange rates,” says Carlos Ghosn, chief executive of Renault, which suffered a €600m loss from emerging market currency weakness last year.
Adidas, whose euro-denominated revenues were hit last year by a slide in the Argentine peso and Brazilian real, warned this month that it would suffer from weakness in the rouble, with political risk afflicting a region where it leads rivals.
In the UK, manufacturers face similar headwinds, as sterling has risen almost 10 per cent in trade-weighted terms over the past year.
The reason this is proving so problematic is that multinationals – while accustomed to hedging against movements in major currencies – have tended not to hedge exchange rate risk in emerging markets that now account for a growing proportion of revenues.
Treasurers find it expensive and at times impossible to protect against fluctuations in volatile and relatively illiquid currencies that may lack developed derivatives markets.
“If a company is going into an emerging market, it’s a very big risk and the currency is a huge component of that,” says Martin O’Donovan, deputy policy and technical director at the Association of Corporate Treasurers.
He adds: “Many people decide to run that risk as part of the hazards of being in that country.”
He believes treasurers had an inherent bias to under-hedge, because overshooting in the other direction would make them seem to be speculating on currencies – and “that is deemed less acceptable”.
Moreover, the recent sell-offs in emerging market currencies followed a couple of years of very low volatility in the euro-dollar exchange rate, the one that usually matters most for corporate hedging strategies. This has tempted many companies to cut hedge ratios.
Now, however, corporate sales executives are reporting a surge in demand for protection against emerging market currency risk.
Fabrice Famery, head of European corporate rates and foreign exchange at BNP Paribas, says that companies were able to absorb the first bout of turbulence in emerging markets, last July and August, but a second sell-off early this year had prompted a “significant increase” in the number seeking to hedge currency risk.
“It puts clients in a dilemma, because if they hedge a currency with high carry long term, it’s very expensive for them,” he says.
BNP Paribas has been exploring ways to offer “discontinuous” hedges – ones that can be interrupted – as a way round the problem, as well as suggesting greater use of options – which are more expensive but “could make sense if you’re a bit late in hedging a currency that has already moved”.
Much smaller companies are also trying to assess and mitigate their currency exposure, says Tony Crivelli, head of global hedging strategy at Western Union Business Solutions. Its UK business handled 15 per cent more forward payments for small and medium-sized companies in the second half of 2013 that in the first half.
Wherever possible, however, multinationals would seek to create “natural” hedges – aiming to have production costs in the same currency as revenues, for example, or raising local currency debt.
A survey published last year by the Bank for International Settlements, the Basel-based organisation that serves as a bank for central banks, notes a long-term decline in non-financial customers’ hedging needs, partly because of the stability of major currency pairs, but also driven by multinationals’ growing sophistication in managing currency exposures, centralising corporate treasury functions, so positions can be netted off internally.
That would also suit the instinct of many executives to steer clear of financial markets. “I’ve spoke to a number of corporates about hedging and they’re a very conservative bunch,” says Jane Foley, a currency strategist at Rabobank. “There is a perception that derivative instruments are by their nature very risky and there is a reluctance by some boards to use them . . . If there was a period of low volatility, it would seem likely that many boards would see that as an excuse not to [hedge].”
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