Foreign Exchange Management
Small Companies – Big Risks?
Export companies are by definition focused on international markets. Despite the promise of increased revenues, exports inherently increase the exposure to currency and other financial markets. Recent events have clearly illustrated the huge impact of currency on price and, by extension, on the market. Regardless of the performance of the Swiss franc, one thing is certain – the past few months have been the most volatile in the history of the euro.
So how do export-oriented Swiss companies deal with these risks? This question is at the heart of an empirical study carried out by Zanders in collaboration with the Institute for Finance at the University of Applied Sciences, Northwestern Switzerland.
Around 100 export-oriented Swiss companies took part, which makes it a representative survey on foreign exchange management. The companies represent a very diverse cross-section in terms of both sector (metals and processing, consulting, construction, chemistry & pharmaceuticals, energy, etc.) and annual turnover (ranging from less than CHF 1 million to over CHF 1 billion).
Do the companies measure their risks?
Companies are aware of the risks – but do they take evasive action? At fi rst it would appear so, with 71% of the companies stating that they regularly quantify their foreign exchange risk. On closer inspection, however, it becomes clear that many of these companies confine themselves to simply translating their foreign currency balances. Even simple scenario analyses are only conducted by a handful of companies. Sophisticated approaches (including statistical procedures and stress tests) are the exception.
The companies that use complex methods are either particularly heavily exposed (with an export share of over 50%) or are suffi ciently large to possess the financial or human resources necessary. However, the survey also revealed that around half a dozen participants take neither a qualitative nor a quantitative view of the risks.
What tools do they use? Unsurprisingly, the use of Excel is prevalent. Treasury management systems or specialized programs (360T, FXALL or Currenex) are used only by the large companies.
Who takes responsibility for foreign exchange risks?
In the majority of cases, responsibility for managing foreign exchange risk is handled by the people in charge of accounting, namely the CFO (50%), or the accountancy staff (34%).
Just 14% of the respondents have focused specialists for the management of foreign exchange – and they are all companies with an annual turnover in excess of CHF 250 million.
How much infl uence does the accounting standard have?
The study addressed another interesting issue: translation losses can also be prevented by keeping the books in the dominant foreign currency. This is legally permitted and, in the past, was often promoted as a simple measure that is quick to implement. In reality, however, almost all the companies surveyed keep their accounts in Swiss francs and a handful in two currencies.
How do the companies manage their foreign exchange risks?
The results so far show that, while the companies recognize their risks, they do not adequately quantify them. In light of this, what exactly does their foreign exchange management involve?
In principle, the management of risks means avoiding, overcoming or bearing those risks with the appropriate safeguards in place. Companies tend to focus most on eff orts to avoid or overcome foreign exchange risks.
The preferred method of avoiding foreign exchange risks is natural hedging (61%). In addition to this, some companies use clauses in contracts (23%) and production outsourcing (8%) to reduce currency risks. The latter measure in particular is politically contentious and is the subject of intense debate among employees’ and employers’ associations.
Roughly 35% of the companies admit to resorting to price increases to overcome the risks. It is interesting to note that more than a third of the companies have the necessary pricing power to respond to the strength of the Swiss franc by revising their prices upwards. This suggests that many have found their niche or off er unbeatable quality which sets them well apart from their competitors.
Which products are used?
Just 40% of the companies engage in ‘true’ hedging of their foreign exchange risks by means of financial instruments. Sixty per cent of the companies do not engage in any form of hedging, despite having rated the importance of foreign exchange management at their company as average or high. The most popular instruments used for hedging are comparatively simple ones, such as forwards, foreign exchange swaps and spots. More exotic or complex options are used rarely by the companies that took part in the survey.
Potential for improvement and a need for investment
Given that relatively few companies hedge the risks, and the great volatility of exchange rates at present, the moot point is whether the companies see a need for investment in foreign exchange management. Two-thirds of the respondents do not invest in this area.
All the same, almost a fi fth of the companies surveyed want to expand or improve their reporting on the currency risk and develop hedging strategies. Around a dozen want to introduce a treasury management system or expand functionalities. None of the companies surveyed have any plans to specifically use hedge accounting pursuant to IAS 39 and IFRS 9. Another measure cited by the companies is the practice of continually reducing their balances in foreign currency. They seek to achieve this by expanding their customer base in Switzerland or making greater use of natural hedging.
Conclusion and summary of the study
The study clearly illustrates that:
- While export-oriented companies are aware of foreign exchange risk, they aren’t always able to quantify it adequately. These risks cannot be managed without knowledge of the risks specific to the company
- The companies are aware of the market risks and their immediate impact on their business results – around one-third believe currency management is an important task
- Foreign exchange management is a managerial task but, in many cases, is delegated to the accounting department. Therefore, an accounting view of the situation prevails. The involvement of the CFO or senior management is not always pursued or guaranteed
- Explicit hedging strategies are the exception rather than the rule
- In light of the performance of the euro and the dollar, it is clear how great the risk is in individual cases with regards to the balance sheet structure and equity. It may even jeopardize a company’s existence
- Swiss export companies must take action as regards hedging – not least because the countermeasures they currently take, such as price increases or natural hedging, will soon prove inadequate if the Swiss franc remains strong
- Decisions about foreign exchange management must be communicated. Depending on the accounting system, this may even be a mandatory requirement in the annual report
There is a need for action among Swiss export companies with regard to managing currency risks. If a company is not aware of its own foreign currency risks, it cannot manage them. The key point is for companies to make both qualitative measurements and, primarily, quantitative measurements. It is not enough to sense the risks, they must actually be measured too.
It is relatively easy to identify and measure the risks with the help of an integrated financial planning system. Furthermore, the question of choosing the right instruments to hedge the identifi ed risks can be reduced to the common denominators of applicability, experience and simplicity. In reality, however, it is only recently that many export companies have had to deal with financial instruments. Therefore, the relevant experience will only be available in exceptional cases. This puts the need for simple instruments into perspective.
Final comments and outlook
Prior to the recent Swiss National Bank’s (SNB) warning that it would not allow the franc to be worth more than 0,83 to the euro, there was no question that there was an urgent need for Swiss export companies to act in the fi eld of foreign currency management.
On the other hand, following this intervention, the question was raised of whether those who had hedged the risks had been made to look foolish.
However, if the strength of the Swiss franc were to continue and the SNB did not intervene, the strategies employed by the majority of Swiss export companies – price increases, natural hedging – would be pushed to their limits. Furthermore, a diff erentiated view ought to be taken: although the SNB’s commitment brings about planning security for companies, as the balance sheet structures solidify and the companies can assess their risks more easily and more accurately, the foreign currency risk will nevertheless, in principle, continue to exist. Besides, it is impossible to determine how long the respite for companies brought about by the SNB will last.