By Ted Howard
International Treasurer’s coverage of FX matters 20 years ago seems eerily familiar.
FX forecasting and hedging were among the predominant themes in International Treasurer’s first year of publication, 20 years ago. Concerns about emerging market FX exposure, the proper way to draft a hedging policy that would minimize the risk of speculation, and just how much faith a treasurer should put in FX forecasting appeared on several occasions. Despite the notable increase in technology and modeling sophistication in the intervening two decades, these remain front-burner issues for treasury today.
Take emerging markets risk. In August 1994, International Treasurer ran a front-page article entitled, “Mexico: Time to Look for Cover?” in which it discussed whether the upcoming election would result in the widely expected devaluation of the peso. Indeed, it was a good question, as the Bank of Mexico soon became unable to support the peso, which led to the Tequila Crisis later in the year. The publication came out in favor of hedging, and doing it soon, before the elections that might close the window of opportunity. Indeed in subsequent years, emerging market currency risk would be a leading concern for corporates as the Brazilian, Russian and Asian Financial Crises sent cross rates plunging across the developing world.
Then turn to the February 18, 2014 issue, which ran an article called, “Don’t Let FX Shocks Happen to You.” In it, corporate giants like Procter & Gamble and Colgate-Palmolive blamed emerging markets currency volatility, prompted by the Federal Reserve’s tapering of quantitative easing, for losses. A month later, International Treasurer published, “Emerging Markets FX Still Threatens as Earnings Bogeymen” in which it cited FiREapps data showing that combined FX tailwinds and headwinds for 200 companies that reported material currency impacts in the fourth quarter totaled $5.65 billion in losses.
But keeping those shocks from happening remains a tough task. Over half the revenues of S&P 500 companies comes from abroad. There are operational issues a company can address, such as how dynamically it manages its FX book, and it can change its hedge ratio, but both have costs.
In fact, in October 2013, International Treasurer published “Survey: Corporates Still Conservative on Risk,” in which it cited a Bank of America Merrill Lynch survey which showed, “Of those respondents who do hedge balance sheets, the majority report less than 100 percent exposure hedging due to “exposure uncertainty.” Further breaking down the results, for FX exposures survey respondents noted the uncertainty of forecasted exposures limit coverage.”
Rewind to 1994 and International Treasurer published one of a series of educational articles in its October 17 issue called, “FX Forecasting Fundamentals.” Author Richard Levich of New York University proposed a framework for using FX forecasts and wrote, “This framework supports their use in the context of considerable skepticism surrounding their validity.” Between Levich’s >article in 1994 and the BAML survey in 2013, it appears that skepticism had not been entirely eliminated.
Hedging decisions are also related to a company’s view on what constitutes speculation. In 1994, there was a lot of soul searching as the MG, P&G and Gibson Greetings derivatives scandals unfolded about how to define hedging in such a way that it minimized speculative activities. In March 1994, International Treasurer ran an article entitled, “Common FX Speculations” that laid out and debunked three fallacies that can lead to speculation: 1) Hedging can be done without a policy; 2) Hedges should make money and 3) Management information systems and internal controls are not necessary to manage FX risks.
Nonetheless, the FX-related losses at P&G and Colgate, and the $5.65 billion lost among the 200 companies in the FiREapps study show that even companies that publicly eschew speculation, and have strong policies against it, can find themselves on the losing side of what unwittingly becomes a speculative position.