There is a lot roiling global markets right now. But that should be no surprise – there has been a lot driving this shake up, even in just the past two years. Whether it’s Brexit, or China’s surprise widening of the yuan trading band or Argentina’s surprise devaluation of the peso, there’s no two ways about it: FX markets are volatile.
Managing through this volatility, corporate finance has learned some important lessons:
1. You never know where volatility will spike next, so it’s important to understand exposure across your entire portfolio of currency pairs.
Where volatility during previous currency crises was largely confined to one region, today volatility is everywhere. The chart below, from our 2015 Q4 Currency Impact Report shows the wide range of currencies contributing to volatility.
In this kind of environment, corporate finance has learned that it’s impossible to predict where volatility will spike next. Furthermore, volatility in currencies that are not a corporate’s largest exposure have had outsized impact on earnings, so corporate finance has learned to manage currency risk across all currency pairs.
2. Not having a handle on FX goes beyond the hit to corporate earnings – it can also mean a personal pay cut.
When corporate leaders report losses from currency volatility, it can impact them personally. As we described in a post the week before last (The FX Effect: How Foreign Exchange Results Could Impact Your Personal Earnings), Burberry CEO Christopher Bailey took a 75% pay cut after “disappointing results.” Those disappointing results arose from a mix of tough challenges. But at least one of the contributing factors – currency volatility – could have potentially been more proactively managed against.
And Burberry’s CEO is just one example. In a 2015 CFO Insights article, Deloitte explained that FX’s recent affect on earnings has created “…a more pressing need to raise the issue of whether or not incentive plans, which are partly impacted by FX fluctuations, should be revisited, and whether or not incentive compensation should be adjusted to reflect unanticipated FX fluctuations.”
3. Sometimes, the biggest impacts are local.
We talk about volatility impacting earnings per share on the consolidated income statement – which it can. But even where volatility isn’t impacting EPS at the corporate entity level, it can affect the general managers at the country or even plant level. Indeed, sometimes the most heated FX impact discussions are not at the board or C-level, but are between the treasurer and the local managers.
That is, in part, because it’s personal. Often, local business managers’ compensation is tied to FX performance; if they don’t hit their financial goals because of FX impacts, it can impact them personally.
Corporate finance has learned that the solution comes down to the data. Often, the people with the most to gain or lose also have the responsibility of getting the data right so that treasury can see the exposures and manage it.
4. Analysts, boards, and now auditors – they’re all asking questions about the impact of volatility.
We’ve been talking for the past couple of years about how analysts are becoming more currency savvy, and asking tougher questions about how corporate finance teams are managing currency impacts. Now in some cases, volatility has also been raising the red flag with auditors.
At one company we’ve spoken with, for example, the FX loss was so significant that it attracted auditors’ scrutiny. The corporate finance team uncovered an accounting irregularity that would have otherwise gone unnoticed. Corporate finance teams are working proactively to uncover poor internal processes that can, and probably will, get the attention of auditors.
If there’s a silver lining in the clouds of the currency storms, it’s that today’s lessons will mean better currency risk management. And although they might be painful, chances are they’re ones that will pay dividends over the long term.