US group Cognizant Technology Solutions (CTS), headquartered in New Jersey, has rapidly expanded its global operations to more than 45 countries since it was spun out of Dun & Bradstreet 16 years ago. CTS has seen a high-growth trajectory with a 10-year compound annual growth of 37% to US$6.1bn revenue in 2011. Approximately 15% of its global revenue is from outside the US.
CTS operates a model whereby the majority of services are performed in its large development centres, primarily in India, Philippines, and China, which invoice the client-facing entities predominantly in the US and in Europe. Consequently much of the costs are incurred in the currencies of development centres, whereas the invoicing is billed in the major currencies.
This business model inevitably leads to FX volatility that can materially impact the company’s income statement. Excessive FX volatility is detrimental from a shareholder value standpoint, as stable operating margins are a key aspect of our investment theme with the investment community. Over the past two years, CTS has created a centralised global treasury function (Global Treasury team (GTT)), which allows for a focused approach to managing global FX exposures. While the treasurer works out of the US, the rest of GTT is based in India.
CTS’ largest non-US dollar (USD) exposure is the Indian rupee (INR), which accounts for 33% of total operating costs. A 1% move in the USD/INR rate will impact operating margins by approximately 0.27%. Additionally, due to intercompany invoicing to our European entities, CTS has balance sheet re-measurement exposures with the key European currencies, primarily British pound (GBP), euro, and Swiss franc.
FX exposure management has proven challenging during the last three to four years as financial markets have witnessed unprecedented volatility. Against this backdrop of significantly growing non-USD exposures, the treasury team faced the complex challenge of minimising the impact of FX gains/losses on the company’s financial results.
INR Cash Flow Hedge Programme
Although a partially-restricted currency, INR is also one of the most vulnerable and volatile emerging market currencies and was the worst performing currency in 2011. We tackled this exposure as follows:
- A structured hedge programme, which was implemented in December 2008 and now extends out up to four years, has been designed to protect against volatility in the USD-INR. We continue to ramp this programme to cover the increased costs associated with expansion of our development centres in India.
- Cash flow hedges are layered in over a four-year horizon with coverage of 60%-65% for the next 12 months; scaled down to 10%-20% for the fourth year out. This layering approach has helped to even out the hedge rates, allowing CTS to effectively capture the swings in forward rates. This is not a rote programme as GTT, in consultation with senior management, has some flexibility to execute hedges when the market and rates are more conducive; thus avoiding locking-up coverage at times of extreme highs or lows of the market. CTS has thus reduced inter-period volatility through diversification.
- An independent study of CTS’ hedge programme by one of our banking partners indicated a 60% improvement in results for the programme when compared year-on-year with either an unhedged or a static hedge programme.
- The ability to hedge out multiple years has improved both the efficiency and efficacy of the programme as this further lessens volatility arising from currency fluctuation, thus eliminating much of the potential FX volatility to the company’s operating margins. Senior management no longer worries about the need to curtail spending on business investment during periods of extreme currency volatility.
Balance Sheet Exposure Management Programme
With over 100 entities worldwide GTT embarked on designing a template for measuring the balance sheet exposures for all currencies, using its enterprise-wide accounting system. The corporation uses the following template:
- Exposures are netted globally to create an accurate company-wide position for each currency.
- Currency exposures beyond a set limit are actively managed to minimise potential impact on the company’s income statement.
- After rigorous testing of various mechanisms used to monitor accuracy and timeliness, GTT resorted to a combination of tools, including both movement of intercompany funds and foreign currency forward contracts, to mitigate the exposures.
- The use of intercompany settlements has been the preferred choice of risk mitigation. After netting the exposures in a particular currency across entities, intercompany trade accounts have been settled where possible to reduce exposures that were above the internally guided threshold.
- Where the exposure is still higher than the accepted level, hedge contracts are executed.
The Result
- CTS analyses each month the efficacy of its cash flow and balance sheet hedge programmes, by independently back-testing the exposures against its financial statements. The programmes are then modified, or tweaked, as inconsistencies arise.
- CTS has improved the predictability of its operating and pre-tax margins by significantly reducing the volatility arising from severe fluctuations in the currency markets.
- This reduced volatility improves earnings visibility and the predictability in the company’s process for pricing of its services.
- Net gains in the INR hedge programme have exceeded US$65m over the past three years, while the company still retains the flexibility of converting 40% of its INR exposures with the spot rate market.
The GTT recognises its responsibility to monitor the company’s FX risks day-to-day. However the team believes that embedding a long term focus into the psyche of all potential stakeholders is critical, so that times of extreme FX volatility do not become fire-fighting moments, to be tackled as these risks arise.
- This case study is based upon an entry into the gtnews Awards for Global Corporate Treasury 2012, sponsored by Bank of America Merrill Lynch (BofA Merrill). The winners of this year’s annual awards, now in its third staging, were only revealed at a gala dinner on 24 May at the Sofitel Grand Hotel in Amsterdam, the Netherlands, after the opening of the two-day gtnews Forum for Global Corporate Treasury conference. This Cognizant entry, which was highly commended, is shared here from the Foreign Exchange (FX) Project of the Year category as a best practice guideline and commentary. To see a full report on all the Awards winners and the gala dinner on 24 May please click here.