Surprise. That is the resounding message in the FiREapps 2013 Currency Impact Report (CIR).
In the fourth quarter of 2013, companies faced one of the most significant headwinds of any quarter we’ve recorded. The total reported negative currency impact was $5.83 billion in Q4, up 39% from Q3. For the year, total reported negative impact was $17.8 billion. Emerging market currencies, including the Brazilian real, continued to be reported as impactful. And analysts asked more detailed questions – about emerging market currencies and others – than in any other quarter recorded.
From emerging markets to analyst questions to the Canadian dollar, the theme for 2013 is surprise. And the message for multinational corporates is this: There are simply too many potential currency pairs on which you could be exposed to manage them all individually.
While the average company has 10’s if not 100’s of currency pairs, none of them can be ignored. Historically, companies may have focused on the five or ten largest exposures, but today the companies that manage risk well are taking the portfolio approach: manage currency risk across all exposures such that the impact of fluctuations falls below a pre-set threshold – no matter which way any currency pair moves. Unfortunately, not all companies are adhering to this and they are typically the ones who are being asked the tough questions by analysts and investors.
Most Impactful Currencies: Surprises Abound
The 5 Currency Culprits – those currencies reported as most impactful – featured some usual suspects, including the Brazilian real and Japanese yen. There were also a number of surprises. The Canadian dollar made a surprise appearance and the Argentine peso made the list for the first time as well. For the first time ever, the euro was not on the list.
Among the 5 Currency Culprits, the biggest story is the impact from emerging markets. Of the 196 companies reporting negative currency impact in the fourth quarter, 96 (49%) mentioned emerging markets. There has always been volatility in emerging markets, of course, but when those markets were growing fast and investment was flowing in, the currency risk was on the upside – companies were looking for positive impacts. Now that growth is slowing in many of the emerging markets, and capital for investment is drying up, the currency risk is on the downside. The acceleration on the downside is much faster than it was on the upside, and as such, companies that did not quantify and mitigate that risk are facing significant negative impacts.
China presents its own currency management challenges. Given the slowdown in the Chinese economy, should China unpeg the currency today, it may well significantly depreciate. We may already be seeing evidence of that: the last week in February the CNH saw its steepest weekly fall against the US dollar since 2005. As the world’s second-biggest economy, currency depreciation in China will have ripple effects around the world, and could deliver very significant negative currency impacts to companies that aren’t prepared.
For most multinational corporates, emerging market currencies remain a smaller percentage of total exposure than the euro. But these emerging market currencies were more volatile than the euro was in 2013. As the Treasurer of a Fortune 100 Internet company explains, “A lot of large moves in very small currencies can hurt you as much as small moves in very large currencies in terms of your exposure to those currencies. When currencies move as much as they have, as it turns out a lot of those small currencies will add up to a large amount.”
Corporates Fielded a Greater Number of Increasingly Sophisticated Analyst Questions
47% of the companies reporting currency impact fielded currency impact-related questions from analysts. That represents the highest percentage of analyst questions ever since we began tracking them in 2011, even outpacing the number and depth of analyst questions at the height of the euro crisis. Furthermore, the questions are increasingly more sophisticated and informed.
Bottom Line: Modern Currency Risk Management Requires a Portfolio Approach
There will always be a surprise – whether it is the Canadian dollar or some other surprise currency doling out an out-of-nowhere impact or market volatility drawing more scrutiny at the point in time that the company is reporting earnings. In an environment in which analysts are asking intelligent, informed questions about currency risk, corporate leaders must be prepared to answer them. For all currencies on which the company is exposed.