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FX Crisis Management: Dealing with Currency Shocks

Stock image: dollar sign dissolving.  Credit: Oliver Denker/Adobe Stock

No company that does business overseas is going to be surprised to hear that currencies are volatile right now and are impacting many multinationals’ bottom line. But Kyriba’s most recent “Currency Impact Report” puts a number to the challenge—and it’s eye-opening.

Every quarter, the firm analyzes the earnings calls of 1,200 large, publicly traded companies that operate outside the financial services sector and are based in either North America or Europe. In May, we reported on Kyriba’s Q2/2022 “Currency Impact Report,” which studied corporates’ Q4/2021 earnings calls. That analysis suggests the foreign exchange (FX) tailwinds that were increasing companies’ earnings per share earlier in 2021 had shifted by the end of the year. By late last year, most multinationals in the study were instead facing headwinds, which had a cumulative impact on North American companies totaling more than $4.5 billion in the fourth quarter.

The recently released October 2022 “Currency Impact Report” shows that those headwinds became much stronger over the first half of this year. Of the 1,200 companies in the most recent Kyriba study, 243 reported currency headwinds in their Q2/2022 earnings calls, and 229 quantified the impact of those headwinds. The aggregate negative impact across all those companies (in both North America and Europe) totaled $37.27 billion. For businesses based in North America that quantified FX effects, the headwinds totaled $34.25 billion, or $155 million per company, on average.

To understand how FX is affecting the typical organization’s financials—and what we should expect in 2023—Treasury & Risk sat down with Andy Gage, senior vice president of FX, risk solutions, and advisory services for Kyriba.

Treasury & Risk: How does the October ‘Currency Impact Report’ reflect what you’re seeing in the real world?

Andy Gage: Every day, I am working with companies of all sizes that are contending with what’s happening in the marketplace. The current challenges are well above and beyond what we typically see. The confluence of FX volatility, the strong dollar, and the changing interest rate—together, these circumstances are putting treasurers and CFOs in a very tenuous position.

T&R: The October 2022 report found that 243 North American companies reported currency impacts on their Q2 earnings, and 94 percent of those quantified the impact. Based on our coverage of ‘Currency Impact Reports’ from previous quarters, that seems like a considerably higher-than-usual proportion of affected companies quantifying the effects of FX on their financials.

AG: You’re right, and I think the main driver of that trend was materiality. The auditors require companies to disclose impacts outside the typical range, so as movements reach this size, companies face pressure to be transparent.

The other thing that’s leading to more disclosure than we’ve seen in the past is that corporate executives are currently being asked a lot of questions—whether by the audit committee, by investors, by stock analysts, or by the press. There’s a lot of focus on FX right now. It’s all over the news; it’s an unavoidable topic. So CEOs and CFOs are trying to explain what’s happening as the trends start showing up in a material way in their financials. And in order to manage expectations, they need to get ahead of explaining the challenges they’re facing before they disclose the actual financial results.

T&R: Among North American companies that quantified their FX impact, the average size of that impact was 10 cents per share, which is obviously noticeable. How are executives communicating what’s causing that?

AG: CFOs and treasurers are taking a lot of actions to try to deal with this really difficult combination of circumstances. It’s a three-part problem: the strong directional move of the dollar and the overall currency market volatility, which keeps spiking given what’s happening in the geopolitical environment. We’ve seen both of these conditions before, but we’ve never seen the dollar at a 20-year high at the same time FX volatility spikes.

And then third—and what’s making this really complicated right now—is the fact that interest rates are shifting, which is changing the cost of hedging. Those higher rates increase the cost of a forward because they’re built into the forward points. So treasury and finance managers are trying to figure out how they can cost-effectively manage the increased risk. Some of the companies I’ve worked with have found that, because the Fed has been raising rates so rapidly, their FX hedging costs exceeded the annual budget before they even got to the midpoint of the year. That’s a real challenge.

T&R: How should treasury groups be approaching financial risk management, considering that both risks and the cost of mitigating those risks are skyrocketing?

AG: I see companies taking two different approaches right now. One is to say, ‘I’ve got a decent hedging program, but I have to figure out how to make it more cost-effective. I can’t avoid the impact of volatility and the strong dollar, but I can be more educated and thoughtful about how I hedge and manage those exposures.’

For these companies, we advise starting with a look inside before they look outside. What can you find inside your company that you can take action on to reduce your exposure? Can you start converting cash at spot rates to reduce the need to hedge that exposure? Can you take advantage of intercompany loans as a way to offset some of the exposure on the balance sheet? I’m seeing a lot of companies doing that.

The next thing we recommend is finding ways to net trades. Sometimes companies hedge on an entity-by-entity basis. Each entity in the organization may have euro-dollar exposure, yet each entity might hedge its euro-dollar exposure independently. In some cases, two business units might have exposures going in different directions, so the cost of both entities buying hedges is unnecessary at the parent-company level. If, alternatively, they roll up all those exposures and net those trades, they can reduce the overall trade volume and reduce the company’s hedging costs.

And then the third tactic we recommend for these companies is using a portfolio Value-at-Risk (VaR) approach. The goal is to understand whether, given what’s happening in the marketplace, there might be correlations between certain currency pairs. If there are, the treasury team can look at the cost of hedging based on those currency pairs and be a little more selective on what currencies they hedge. The reduction in trade volume would drive down costs.

T&R: What is the other approach you’re seeing treasury teams take to deal with the trifecta of market trends that are driving up hedging costs?

Read Andy’s response in Part 2 of this article, which will publish early next week.