Asian Corporates Need More Hedging amid FX Volatility
In countries across Asia similar scenes are regularly playing out, as currencies around the region drop against the US dollar (USD), or as other foreign exchange (FX) rates shift more frequently than before.
In some cases that FX volatility may help firms. A recent Dow Jones report cited data from Hedge Fund Research Inc, showing that in 2015
currency funds enjoyed their best start to a year since at least 2008
, while another research firm, Barclay Hedge stated that funds using algorithms to chase market trends reaped their biggest monthly gains in a decade in January. More often, however, the effect on other firms has been negative.
A. G. Lafley, who last year returned to consumer products giant Procter & Gamble for a second stint as chief executive (CEO), warned of the effects of volatility in P&G’s latest quarterly report. He said that while the company continues to make steady progress on its strategic transformation (P&G announced plans last August to halve its brands portfolio), earnings were hit by the “unprecedented currency devaluations” and “the considerable business portfolio, product innovation and productivity progress was not enough to overcome foreign exchange.”
Even Japan’s huge US$1.1 trillion pension fund is a case in point, as it does not hedge and may be affected by FX volatility. It is “unbelievable” that the Government Pension Investment Fund (GPIF), with 38.7 trillion yen (JPY) (about US$325bn) in assets outside Japan, doesn’t protect against fluctuations in the currency, Gakushuin University professor and GPIF investment committee member Junko Shimizu told
news agency. “My personal opinion is that they should look to hedge.”
While a key solution to currency volatility is hedging, independent treasury consultant David Blair told
magazine that many corporate treasurers have not yet have acted on the recent sharp depreciations of many currencies. “It generally takes them a while to change hedging policies, so I doubt if this year’s heightened volatility has yet materially affected corporate hedging behaviour,” he said.
Small or medium enterprises (SMEs) stand to be particularly hard hit, as they may have less access to sophisticated hedging techniques than large corporates, or less awareness of the need to hedge. In Singapore, for example, United Overseas Bank (UOB) has reported that only 14% of its small business customers currently use currency conversion or hedging solutions.
Yet even large corporates may need to do more, as the Reserve Bank of India (RBI) emphasised when pushing Indian corporates to hedge their FX exposure more actively. The RBI is keen to strengthen the country’s defenses against the risk of currency turmoil, to avoid India becoming hostage to global developments. “Corporates are not hedging enough,” a senior policy maker aware of the central bank’s thinking, told
Volatility in FX rates is predicted to continue this year, reflecting divergent US and European central bank policies, fluctuating oil prices and unexpected central bank actions. The latter includes the sudden removal, in January, of the cap on the rate between the Swiss franc (CHF) and the euro all potentially leading to more fluctuations. Given the likelihood of currency volatility continuing, companies large and small would be well advised to focus more on hedging.
According to David Blair, to start with transaction hedge duration should be based on the pricing cycle. Since hedging targets stable margins, at least from an FX perspective, companies should hedge the full duration of their commercial pricing cycle.
One option is for them to hedge as many of their exposures as possible, in order to keep the risk of being exposed to FX fluctuation to a minimum. Another is to minimise hedging activity by using internal resources and techniques, such as resolving certain types of FX exposure by netting or matching payments.
Companies can also use forward contracts – the most widely-used external hedging technique – to buy or sell a fixed amount of currency at a fixed rate. Having a centralised currency information system, so that the company can identify all of its FX exposures, and using the information to select the appropriate hedge is essential, of course, regardless of which technique a company uses.
More Volatility Ahead
One multinational that has finally stepped up its hedging activity is glassmaker Corning. Conceding that the yen is likely to remain weak for the next few years, finance chief James Flaws told the
Wall Street Journal
that the company has changed its hedging strategy to protect only against further JPY depreciation.
While hedging has sometimes been costly and challenging in the past, financial institutions and even non-banks are making it at least rather more accessible. Whether they protect against fluctuations in the JPY, USD or other currencies, companies would be well advised to review their hedging strategy if they have one – and set one up if they do not.