Hedging Foreign Exchange Translation Exposure: The Dilemma



December 8, 2017 GTNews.com (http://www.gtnews.com) Home (http://www.gtnews.com)Categories (http://www.gtnews.com/categories/) Banking (http://www.gtnews.com/category/banking/) Cash Management (http://www.gtnews.com/category/cash-management/) Centralisation (http://www.gtnews.com/category/centralisation/) Financial Supply Chain (http://www.gtnews.com/category/financial-supply-chain/) Financial Planning & Analysis (http://www.gtnews.com/category/fpanda/) Industry Sectors (http://www.gtnews.com/category/industry-sectors/) Investment & Funding (http://www.gtnews.com/category/investment-and-funding/) Payments (http://www.gtnews.com/category/payments/) Regions (http://www.gtnews.com/category/regions/) Regulation (http://www.gtnews.com/category/regulation/) Risk (http://www.gtnews.com/category/risk/) SEPA (http://www.gtnews.com/category/sepa/) Technology (http://www.gtnews.com/category/technology/) Insights (http://www.gtnews.com/insights/) News (http://www.gtnews.com/latest-news/) Articles (/articles) Blogs (/blogs) Industry Updates (/industry-updates) Global Treasury Briefing (/global-treasury-briefing/) Resources (http://www.gtnews.com/resources/) Case Studies (/casestudies/) Whitepapers (/whitepapers/) Webinars (/webinars/) Research & Guides (/research/) Videos (/videos/) Events (/events) Treasury Leaders Summit (http://www.treasuryleaderssummit.com/) Jobs (http://www.accountancyagejobs.com/jobs/treasury/) Directory (/companies) About Us (http://www.gtnews.com/about-us/) Our Team (http://www.gtnews.com/our-team/) Promote Your Business (http://www.gtnews.com/promote-your-business/) Cookie & Privacy Policy (http://www.gtnews.com/cookie-privacy-policy/) Editorial Guidelines (http://www.gtnews.com/editorial/) Editorial Agenda 2017 (http://www.gtnews.com/editorial-calendar/) Subscribe (http://www.gtnews.com/subscription-gtnews-html/) (http://www.gtnews.com) > Investment & Funding (http://www.gtnews.com/category/investment-and-funding/) > Economy (http://www.gtnews.com/category/investment-andfunding/economy/) > Hedging Foreign Exchange Translation Exposure: The Dilemma

Hedging Foreign Exchange Translation Exposure: The Dilemma

09 Dec 08 | Author Richard-Mark Dodds (http://www.gtnews.com/author/richard-mark-dodds/) | Economy (http://www.gtnews.com/category/investment-and-funding/economy/) FX Risk/CLS (http://www.gtnews.com/category/risk/fx-risk-cls/) Investment & Funding (http://www.gtnews.com/category/investment-and-funding/) Risk (http://www.gtnews.com/category/risk/) Recommend 1 Share Tweet

The translation exposure of a corporate can be defined as the net foreign investment exposure held in foreign currencies that must be translated into group reporting currency at the end of each financial reporting period. It differs from transaction exposure, which is the exposure to foreign currency cashflows, typically sales and from economic exposure, where foreign exchange movements can be of benefit to you or your competitors depending on the relative strength or weakness of the currencies in which the respective cost and revenue centres are. Translation exposure remains a non-cash item in balance sheet exposure in other comprehensive income (OCI)/net equity until the asset is sold, and has no impact on the profit and loss account or earnings per share (EPS) until this point. Typically, the corporate CFO and treasurer will note that equity analysts are principally focused on EPS and that multinationals will always maintain foreign net assets via foreign subsidiaries, and so in the very long term ‘it is all a wash’, which is a very valid point to a degree. Detailed academic research on translation exposure, beyond text book theory, is relatively limited1 and concludes that hedging translation exposure is key if a corporate is highly leveraged to protect banking covenants, and also that credit rating agencies have added some focus on large movements in corporate OCI/net equity reserves. It is certainly the case that there is a very diverse approach to hedging translation exposure in practice and shortly we will consider some specific examples, however the following points need to be considered: When your group reporting currency is strong, not having full transaction exposure hedges will already impact your EPS (and the residual flow to OCI/net equity). In this situation you will likely also have translation exposure revaluation losses, too. If you make a foreign acquisition, or launch a significant new product with a foreign subsidiary, this will result in more risk, at least until it becomes clear that it is a sustainable part of your company going forward. Assuming your foreign subsidiaries are generating net income, hedging translation exposure is a form of hedging future foreign dividend streams. Not directly related, but if you have to put your pension fund on balance sheet, this may also impact your OCI/net equity. Your ability to pay a dividend may be influenced by decisions related to your overall level of OCI/net equity.

Companies Managing Translation Exposure From publicly available information, Reckitt & Benckiser, Kellogg’s, IBM, Johnson & Johnson, Black & Decker and Electrolux are companies who identify and selectively manage their translation exposure. As of November 2008, these six companies have the same or higher credit rating than in 2000 and their share price has risen by an average 60% since then, while the S&P 500 during the same period fell 40%. An example of a company, which didn’t historically actively manage translation exposure, is Coca Cola. At the end of 2002, Coca Cola had US$2.7bn of accumulated foreign exchange (FX) translation exposure losses, a sum which at the time was approximately the same as the company’s long term debt and not insignificant compared to Coca Cola’s US$11.8bn of net equity. In 2003, Coca Cola reported translation exposure gains of US$0.9bn, creating huge swings in OCI/net equity. Coca Cola is now more actively involved in net investment (translation exposure) hedging of foreign subsidiaries. Given volatile FX markets in 2008, many multinational companies will likely report significant changes in OCI/net equity in this financial year resulting from translation exposure. The information sources for the above are from Bloomberg and SEC10K Filings.

Translation Exposure: The Dilemma Whether a corporate treasury decides to hedge or not their translation exposure, they should certainly identify the risks involved, understand what this potentially means for the business and quantify them with a value-at-risk (VaR) analysis. As noted earlier, translation exposure is a non-cash item until an asset is sold (when it does impact cash flow/profit and loss and EPS) and it does not make sense to hedge a non-cash item with a cash instrument, such as an FX outright forward, as this could lead to potentially significant cash flow mismatches over time. A cross-currency swap can be a suitable instrument but is essentially similar to the FX forward outright if in a fixed/fixed format and if either leg is floating this is effectively taking a view on interest rates. Raising local debt in foreign (non-group reporting) currencies effectively matches assets and liabilities in the foreign subsidiary but then the parent company will likely have to issue guarantees as these subsidiaries will have themselves limited net equity. Additionally, unless you are a truly global brand, there may be additional costs from debt issuer spread outside of your home country. Reviewing your group reporting currency can be another way of reducing translation exposure. Given that many emerging market countries are pegged to the US dollar, this often means that many companies actually have a much higher exposure to the US dollar than is apparent at face value. In Switzerland: Novartis, Syngenta, Synthes, ABB, Zurich Insurance, Glencore and Logitech all report in US dollars, while Richemont, Adecco and Nobel Biocare report in euros. It can also potentially assist with analyst benchmarking and economic exposure issues. Buying longer dated currency options with an asymmetric risk profile, however, can be a very suitable instrument for hedging translation exposure, especially when utilised in a form such as multi-year compound options or an option on an FX forward. Liquidity in dollar cash settled emerging market options has also developed significantly on a global basis (i.e. Brazil), even where there is a no onshore deliverable currency market and NDFs are the only other alternative. Volatilities can often be below those of G10 currencies. Longer dated option premiums can often be relatively small, on an annualised basis, to avoid accounting designation.

Conclusion Translation exposure is an important issue, even for those companies, which have high levels of net equity/OCI. Examples have been provided of very successful companies who have translation exposure on the radar. It is important to understand what your VaR is and what the potential consequences of not hedging are. As for implementing translation exposure hedging, there are several tools that can be used and also ways in which translation exposure, where appropriate, can be potentially reduced by reviewing group functional currency. Once minimised, buying longer dated currency options, with their asymmetric risk profile, including for emerging markets, can be one of the most effective instruments available. However, hedging application needs to be done tactically and consistently in line with a defined treasury policy. Buying insurance (options) when the house is already on fire, will not be the most cost effective strategy. Some reference also needs to be taken to the predetermined purchasing power parity of a currency and perhaps when there is 30% to 40% undervaluation of your group reporting currency, extra vigilance needs to be observed. 1 Academic References: Hagelin, Niclas and Pramborg, Bengt “Hedging Foreign Exchange Exposure: Risk Reduction from Transaction and Translation Hedging” (May 28th , 2002); Bonini,

Stefano, Dallocchio, Maurizio, Raimbourg, Philippe and Salvi, Antonio,Do Firms Hedge Translation Risk?(May 12, 2007). 2299 views

Related reading


101: How to buy and transfer cryptocurrencies on Coinbase (http://www.gtnews.com/articles/101-how-to-buy-and-transfer-cryptocurrencies-oncoinbase/) 30 Nov 17 | Author Victoria Beckett (http://www.gtnews.com/author/victoriabeckett/) | FX Risk/CLS (http://www.gtnews.com/category/risk/fx-risk-cls/) Investment & Funding (http://www.gtnews.com/category/investment-and-funding/) Payments (http://www.gtnews.com/category/payments/) Risk (http://www.gtnews.com/category/risk/) Technology (http://www.gtnews.com/category/technology/) Trading (http://www.gtnews.com/category/technology/trading/) | (http://www.gtnews.com/articles/101-how-to-buy-and-transfercryptocurrencies-on-coinbase/#comment) Despite the price of bitcoin being predicted to break $10,000 at the end of 2017, it is currently worth $11,126 (5pm, November 29, 2017) after surging from $10,000 to $11,000 in less than 24 hours. Read our 101 article on how to set up an account and buy bitcoin, ethereum and litecoin on Coinbase.


Balancing the risk of the currency exchange (http://www.gtnews.com/articles/balancingthe-risk-of-the-currency-exchange/) 21 Nov 17 | Author Lee McDarby (http://www.gtnews.com/author/leemcdarby/) | Economy (http://www.gtnews.com/category/investment-and-funding/economy/) Investment & Funding (http://www.gtnews.com/category/investment-and-funding/) Investment Management (http://www.gtnews.com/category/investment-and-funding/investment-management/) | (http://www.gtnews.com/articles/balancing-the-risk-of-the-currency-exchange/#comment) For UK treasurers looking to manage financial risk within their organisation, recent news of an interest rate rise from 0.25% to 0.5% was a mixed blessing.


Analysing FX exposures to understand risk (http://www.gtnews.com/articles/analyzing-fxexposures-to-understand-risk/) 16 Nov 17 | Author Stephen Barr (http://www.gtnews.com/author/stephenbarr/) | Economy (http://www.gtnews.com/category/investment-and-funding/economy/) FX Risk/CLS (http://www.gtnews.com/category/risk/fx-risk-cls/) Investment & Funding (http://www.gtnews.com/category/investment-and-funding/) Risk (http://www.gtnews.com/category/risk/) | (http://www.gtnews.com/articles/analyzing-fx-exposures-to-understand-risk/#comment) Whether responding to questions from other stakeholders or seeking to monitor the effectiveness of their risk management processes, treasurers and FX managers in growing companies with expanding foreign currency exposures need solid analytics to support their decision making.


Is Asia too risky for corporate investment? (http://www.gtnews.com/articles/is-asia-toorisky-for-corporate-investment/) 15 Nov 17 | Author Richard Hartung (http://www.gtnews.com/author/richard-hartung/) | Asia Pacific (http://www.gtnews.com/category/regions/asia-pacific/) Economy (http://www.gtnews.com/category/investment-and-funding/economy/) Investment & Funding (http://www.gtnews.com/category/investment-and-funding/) Investment Management (http://www.gtnews.com/category/investment-and-funding/investment-management/) Regions (http://www.gtnews.com/category/regions/) | (http://www.gtnews.com/articles/is-asia-toorisky-for-corporate-investment/#comment) From corporates investing in Asia to small and medium enterprise (SME) suppliers wanting to make sure they get paid, companies are trying to discern whether countries and counterparties in Asia are actually risky. Tags:






Sort by Best


Start the discussion…


Add Disqus to your siteAdd DisqusAdd


Follow Follow

UNMISSABLE FINANCE INSIGHTS Bi-weekly news and editorial on key issues facing treasury and finance professionals.

Your email address



Featured Companies (http://www.gtnews.com/companies/standard-chartered/?gae_category=marketplace&gae_action=featured_widget_click&gae_label=company_1531&featured_company=1)






Latest Research & Guides CGI Transaction Banking Survey Report 2017 (http://www.gtnews.com/research/cgitransaction-banking-survey-report-2017/) CGI and GTNews present the fifth annual Transaction Banking Survey, which offers which offers ...

GTNews SWIFT Supplement 2017 (http://www.gtnews.com/research/gtnews-swiftsupplement-2017/) This latest guide by GTNews reviews the most recent transformative developments, such as the ...

Global Treasury Briefing – December 2016 (http://www.gtnews.com/research/globaltreasury-briefing-december-2016/) Welcome to the December edition of the Global Treasury Briefing.

bobsguide & GTNews Treasury Management Systems Guide 2016/2017 (http://www.gtnews.com/research/bobsguide-gtnews-treasury-management-systemsguide-20162017/) This bumper edition of the bobsguide & GTNews TMS Guide is full of features and commentary from ...

Most Popular (http://www.gtnews.com/articles/how-treasury-stands-to-benefit-from-blockchain-ripples-goal-to-revolutionize-cross-border-transactions/)

How treasury stands to benefit from blockchain: Ripple’s goal to revolutionise cross-border transactions (http://www.gtnews.com/articles/how-treasury-stands-to-benefit-from-blockchain-ripples-goal-to-revolutionizecross-border-transactions/) (http://www.gtnews.com/2017/11/28/psd2-the-death-of-mt940s/)

PSD2: the death of MT940s? (http://www.gtnews.com/2017/11/28/psd2-the-death-of-mt940s/) APIs may be a solution to MT940 challenges, says Karen Fagan, treasury operation manager, for British television company, ITV. (http://www.gtnews.com/articles/the-boe-launching-digital-currency-on-blockchain-tech-would-be-international-payments-game-changer/)

The BoE launching digital currency on blockchain tech would be international payments 'game changer' (http://www.gtnews.com/articles/the-boe-launching-digital-currency-on-blockchain-tech-would-be-internationalpayments-game-changer/) (http://www.gtnews.com/articles/swift-message-mt202-cov-background-and-impact-points-for-banks/)

SWIFT Message MT202 COV: What are the background and impact points for banks? (http://www.gtnews.com/articles/swift-message-mt202-cov-background-and-impact-points-for-banks/) Tweets by @gtnewsdotcom gtnews.com @gtnewsdotcom Don’t be scared of #failure, but fail fast: @BNPParibas Cash Management University bit.ly/2BIpZTL


gtnews.com @gtnewsdotcom #CorporateInnovation : It is more of an announcement culture rather than an action culture - Omeed Mehrinfar @pnpfintech @BNPParibas CMU 2017


View on Twitter

Click here to advertise with us (http://www.gtnews.com/promote-your-business/) Follow Follow

Powered By (http://www.contentive.com) (http://www.bobsguide.com) 1 Broadway Hammersmith London United Kingdom W6 9DL [email protected] (mailto:[email protected]) [email protected] (mailto:[email protected]) [email protected] (mailto:[email protected]) [email protected] (mailto:[email protected]) [email protected] (mailto:[email protected]) Categories Banking (http://www.gtnews.com/category/banking/) Cash Management (http://www.gtnews.com/category/cash-management/) Centralisation (http://www.gtnews.com/category/centralisation/) Financial Supply Chain (http://www.gtnews.com/category/financial-supply-chain/) Financial Planning & Analysis (http://www.gtnews.com/category/fpanda/) Industry Sectors (http://www.gtnews.com/category/industry-sectors/) Investment & Funding (http://www.gtnews.com/category/investment-and-funding/) Payments (http://www.gtnews.com/category/payments/) Regions (http://www.gtnews.com/category/regions/) Regulation (http://www.gtnews.com/category/regulation/) Risk (http://www.gtnews.com/category/risk/) SEPA (http://www.gtnews.com/category/sepa/) Technology (http://www.gtnews.com/category/technology/) Home (http://www.gtnews.com/) Categories (http://www.gtnews.com/categories/) Insights (http://www.gtnews.com/insights/) Resources (http://www.gtnews.com/resources/) Events (/events) Treasury Leaders Summit (http://www.treasuryleaderssummit.com/) Jobs (http://www.accountancyagejobs.com/jobs/treasury/) Directory (/companies) About Us (http://www.gtnews.com/about-us/) Subscribe (http://www.gtnews.com/subscription-gtnews-html/) Cookie & Privacy Policy (http://www.gtnews.com/cookie-privacy-policy)


Hedging Foreign Exchange Translation Exposure: The Dilemma

TI_sitewide_header_728x90 December 8, 2017 GTNews.com (http://www.gtnews.com) Home (http://www.gtnews.com)Categories (http://www.gtnews.com/catego...

449KB Sizes 16 Downloads 22 Views

Recommend Documents

Hedging Foreign Exchange Exposure: Risk - (SSRN) Papers
May 28, 2002 - Further, we investigate risk reduction from using different hedging instruments, and particular .... 2 Ec

"Hedging Preferences and Foreign Exchange Exposure Management
... clear understanding of economic exposure, transactions exposure and translation exposure; (b) determine whether the

Limiting Foreign Exchange Exposure through Hedging: The Australian
variability, including through the development of the hedging practices of financial institutions and non-financial firm

financial and operational hedging of exposure to foreign exchange
14 Dec 2015 - different econometric models to estimate the hedge ratio fails either to add value or improve the effectiv

Foreign Exchange Rate Exposure, Hedging and Cash Flows
Jan 9, 2008 - Institute for the World Economy during visits to these institutions. The Maastricht ... these currencies,

Foreign Exchange Exposure - PURE
ing and multinationality have different effects. ... reducing both risk and FX exposure (insignificantly), multinational

hedging foreign currency transaction exposure - StudyFinance
Hedging Foreign Currency Transaction Exposure: The Importance Of Real Rates Of Interest .... variations across the diffe

Three Types of Foreign Exchange Exposure | Bizfluent
Sep 26, 2017 - Growth of international business has led to an increasing exposure to foreign exchange risk for many comp

Exchange Rate Exposure, Foreign Involvement and Currency
Exchange rate exposure is usually divided (e.g. Shapiro (1996)) into three different types: transaction, translation and

Managing your foreign exchange exposure - CIBC
year and with any amount of foreign currency. Foreign exchange fluctuations can present a risk to your business. Unpredi