Surprised by Currency, European Corporates Rethink Their Management Programmes

Relative to the USD, the euro defied expectations in the first three months of this year, and that led to earnings surprises for many corporates. In December 2013, the mean estimate in a Bloomberg survey had the euro against the US currency falling from €1.3758 to €1.28 in 2014. But at the end of Q114, the euro was at €1.38. European corporates also reported significant negative impacts from smaller yet more volatile emerging market (EM) currencies, including the Russian ruble (RUB) – down as much as 11% against the euro in Q1 – and the Turkish lira (TRY), which fell by as much as 8%.

Rethinking the Problem

These recent earnings surprises have led many corporates to rethink what the root cause of currency impacts really is. While many European corporates once focused on making better forecasts, many are now realising that it is not always forecasting at issue. In fact, there have been instance of companies taking significant earnings hits despite on-target forecasts, because of other issues that can arise in a multicurrency accounting environment.

The root cause of the €3.08bn currency impact was not bad forecasting; rather it stemmed from a lack of accurate, complete and timely (ACT) visibility into currency exposures.

When corporates set their Q114 budget rate at the end of last year, analysts were forecasting that the euro would fall as much as 7% against the USD in 2014. In January, corporates began hedging transactions, forecasted sales and expenses to those budget rates. As is customary in Europe, most treasurers hedge each forecasted transaction according to the budget rate until the transaction is expected to close. However they often have a hard time figuring out when the transaction actually closes, so wait until the end of the month to decide whether or not to close the hedge.

When the transaction actually closes within the month, but the hedge stays open until the end of the month it can involve significant hedging costs. It can also lead to significant currency surprises when the rate at the point of transaction maturity and the rate at the point of hedge maturity are very different.

When exchange rates generally follow expectations and are not particularly volatile, this method of transaction hedging may not result in significant currency impacts on earnings. However, when rates defy expectations and/or are very volatile – as they were in Q1 – then significant earnings impacts may emerge, as they did.

In addition to timing, a lack of complete visibility into actual exposures is a root cause of currency surprises. To take one example, a European corporate had assumed that its entities in Sweden were only generating euro/krona (SEK) exposure, and was surprised with a significant Russian ruble impact. The company did not have visibility into the fact that its Swedish entities had RUB income.

Many more factors than just the rate forecast or the hedging programme affect how currency impacts the income statement. When the company opens a new plant in an emerging market, for example, that creates a new exposure. If the company changes its contract terms so that invoices are paid in another currency that creates a new exposure. If the company begins selling into a new market, that creates new exposure.

All of those operational decisions create currency exposure, and if they’re not visible to the treasury organisation then they can’t be accounted for in the forecasting process – and that leaves the corporate open to currency impact. In other words, a multinational corporate (MNC) has a lot of operational complexity. That is where corporates – even if the rate forecast is on target – can be impacted by currency.

Reexamining Hedging Processes

It is now clear to many corporates that the old process of hedging specific forecasted transactions no longer works. Regardless, investors still expect the chief financial officer (CFO) and the treasury organisation to mitigate the impact of currency on earnings. This combination of factors is forcing corporates to re-examine their currency risk management processes. They are examining their budget rate setting processes; how they detect, define, and analyse currency exposures; and how they actually manage their exposures.

Ultimately, corporates need to better align their currency risk management activities with what is actually happening in the business. So, for example, some corporates are redesigning their processes to separate the management of top-line currency risk from the management of balance sheet risk. That way, the treasury organisation can manage balance sheet risk in real time.

Furthermore, by analysing and managing exposures as a portfolio, corporates are achieving better hedge performance and doing so at a lower cost.

Instituting an Analytic Framework

Getting the kind of accurate, complete, and timely (ACT) visibility that many European corporates now understand they need requires instituting an analytic framework that bridges the accounting and treasury organisations. The analytic framework allows the treasury organisation to see every currency exposure in the business, and thereby understand the effect that operational decisions might have on those exposures and, by extension, on earnings. In that way, the analytic framework can mitigate currency impacts that are often preventable, and always explainable.

Once a corporate has visibility into and understands what is really happening in the business, the analytic framework enables the treasury organization to look back and see what has happened. Take the
electronics manufacturer Plantronics
, for example. It leveraged its analytic framework to go into the enterprise resource planning (ERP system to find the month when the accounting organisation changed the business process that inadvertently changed the way exposure was defined and put the treasury organisation’s currency risk management programme out of alignment.

Plantronics had the visibility to go back, find that point in time and resolve the issue moving forward. That is a perfect example of the kinds of multicurrency accounting process issues that can derail a currency risk management programme but into which corporates, without an analytics framework, have no visibility.


In summary, a confluence of factors in Q114 – from a euro that defied expectation to volatile EM currencies – have led many European corporates to rethink the root cause of earnings surprises, re-examine their hedging processes, and take the first steps toward instituting analytic frameworks that give them accurate, complete, and timely visibility necessary to avoid significant currency impacts to earnings – no matter what happens in the market.

Those moves will be critical to protecting European corporates when the Federal Reserve Bank raises interest rates and the USD strengthens. Imagine the outcome for any corporate that doesn’t take action to get accurate, complete, and timely visibility into their currency exposures – the kind of earnings impacts dealt by the TRY and RUB in Q1 could be magnified tenfold.


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