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Exporter currency ri sk

Protecting
Economic P&L's
By j effrey Wall ace
Greenwich Treasury Advisors
For those companies who want to pro-
tect and maximize their consolidated
US dollar P&l on both an economic
and reported basis, the answer is
clear: move to US dollar functional
currency, especially for foreign sub-
sidiaries that are worldwide exporters.
Mul ti nationa l s w i t h fo rei gn sub-
sidiari es that are worldw ide exporters
with multi currency revenues have a
major strategic issue: how to manage
each exporter's resul ts in the currency
that max imi zes parent shareholder
wealth. Or to restate it in operational
terms, are parent shareholders better
off if local management is compensat-
ed for max imizing their P&L in local
currency or parent currency terms?
Whil e most companies manage t heir
fo rei gn wor ldw ide ex po rt er s o n a
local currency basis, there is littl e eco-
nomic j ustificati on for it. By parochi al-
l y maximi zing the l oca l c urrency
results of multicurrency revenues (and
often multi currency expenses), local
manage ment effecti ve l y av oi ds
responsi bili ty for the most important
FX exposure it has: t he local exposure
against the parent's currency. Having
local management focus on local cur-
rency resul ts, moreover, abdi cates a
major responsibility to the parent trea-
sury, w hi c h may be t housa nd s of
mil es and several time :zones away.
By comparison, an export operati on
in th e parent country with forei gn-
sourced components and t he sa me
multi currency revenues would be
managed in th e c urr ency of t he
parent- with littl e argument. Yet, in
both these situat ions, the cross-curren-
cy ri sks to the parent shareholders are
the same.
Why should FX management di ffer
by locati on if the exposure does not ?
Internat ional Treasurer/ September 19, 1994
Professional Guidance: Currency Management
In the case of foreign export subs, par-
ent shareholders are clearl y better off
i f t he mul t i curre ncy rev enues and
expenses are managed locall y to max-
imi ze pare nt c urrency r es ul ts .
Otherwise, local currency results are
maximized and then managed (or not
managed, as the case may be) a sec-
ond time into the parent currency by
treasury at headquarters.
Why, then, are U.S. multinational s
at l east, subopt imi z ing their share-
holder wealth ? There are two strong
factors favoring local currency maxi-
mi zati on: local management and FAS
52's definiti on of functional currency.
Local management bias
With a local currency expense base, it
is understandable why local manage-
ment wants to max imi ze local curren-
cy results. After all , it is one less cur-
rency risk to manage. Bonu ses are
hard enough these days without mak-
ing it any more di fficult.
Also, if local subsidi ary management
is reall y local, then there can be emo-
t ional reasons for favoring the local
currency. In additi on, there are real,
but not insurmountabl e, techni cal dif-
f i culti es in managi ng l ocal currency
cash flows when the FX hedges con-
vert the operat ing f lows to the parent
currency.
However, if there were any validity
to the supposed probl ems created by
managing on a US doll ar functi onal
currency basis, they are beli ed by the
experi ence of many multinational s
successfull y operating on thi s basis for
over a decade in hyperinf l ati onary
countries.
In add iti on, there i s the successful
experi ence of suc h we ll - respected
compan ies as Al coa , Amoco ,
Chevron, Compaq, Du Pont, Eastman
Kodak, Motorola, and Rohm & Haas.
All of these compani es use US doll ar
functi onal currency for all or most of
their foreign subsidi ari es that are not
operating in hyper infl at ionary env i-
ronments (thi s is according to the New
Yor k Uni vers it y Sal omon Cent er,
1993) .
GAAP considerations
Loca l management's l ocal currency
favo riti sm i s co mpounded by t he
account ing. Many compani es auto-
mati cally made the local currency the
functional currency when they impl e-
mented FAS 52 in 1982. However, as
Ro bert Herz and Bob Bh ave of
Coopers & Lybrand expl ained in the
l ast i ssue of International Treasurer
("The Currency to Hedge" , September
5, 1994), P&L hedging by the parent
treasury is awkward because hedge
accounting treatment is avail able for
hedging into the f uncti onal currency
but not into the parent's currency.
Thu s, any parent currency hedges
must be marked quarterly, increasing
reported P&L volatility.
Parent senior management
For compani es who beli eve that maxi-
mi zing their hedged US doll ar P&L is
more important than maximi zing their
unhedged l ocal currency P&Ls, the
onl y feas ibl e solution is to change to
US doll ar f unct ional currency. Thi s
achi eves the ri ght hedge accounting
treatment for the FX hedges necessary
to do this. Becoming US doll ar func-
ti onal is parti cul arl y appropri ate for
worldw ide exporters f or the reasons
argued above.
In-house accountants may argue that
changing to US doll ar functi onal cur-
rency will be di fficult to justify to the
aud i t ors- that it i s not " GAAP. "
However, in my experience, auditors
all ow tremendous latitude in interpret-
ing how FAS 52 is actually appli ed.
If seni or management is trul y con-
vinced that economi cally their share-
holders' returns are better maximi zed
by managing the foreign subs on a US
doll ar bas is and have an active US
doll ar hedging program, there are few
auditors who w ill not agree to US dol-
lar functi onal currency. After all , the
auditors down the street w ill gl adl y
take over the engagement.
-
Mr. Wallace is reached at (203) 53 7-0835.
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