Are you a treasurer or FX manager? Do you have a management objective tied to FX gain/loss? If you do, you’re in good company. If you don’t, your peers do – and they’re better for it.
Among the 37 FX managers from leading multinationals at the recent NeuGroup FX Managers’ Peer Group Summit, many had MBOs (management objectives) related to foreign exchange impact. Of those who had an MBO, it was agreed that the largest acceptable currency impact from balance sheet exposures alone was 1-cent of earnings per share (EPS). Some had MBOs much lower than that.
65% FX management program effectiveness? Not good enough
A decade ago, an acceptable outcome for a treasurer’s FX management program was 65% effectiveness (meaning that 65% or more of the company’s FX gains or losses were offset through risk management). Today, that’s no longer acceptable; 95% effectiveness is the new standard expectation among executives, and many companies are striving for – and achieving – 99% effectiveness.
The increase in expectations among executives follows two trends: 1) with increasing internationalization (increased currency exposure) and increasing currency volatility, 65% FX program effectiveness will likely result in a painful and unacceptable currency impact; and 2) with the introduction of cloud-based technologies, it is possible to manage currency risk to any threshold you set.
The new metric in town: Currency impact less than 1-cent of EPS
While FX program effectiveness is measured as a percentage, beginning over the past couple of years, executives actually are looking at open risk: if the treasurer’s FX program is 95% effective, what does the remaining 5% mean in risk terms? Is that risk less than 1-cent of EPS? FX risk management has come a long way; now it is recognized that looking only at the effectiveness percentage – without looking at open risk – is not sufficient.
As companies’ currency exposures increase and as currency volatility increases, a less than 1-cent of EPS impact requires increasingly more effective FX management – for some companies, 95% effectiveness may not even suffice to keep currency impact below 1-cent of EPS.
Why a 1-cent of EPS target matters
Without good currency risk management, EPS is at risk. Risking earnings per share is dangerous business because investors tend to dump stock first and ask questions later when earnings fall short of expectations. Furthermore, reduced EPS means the company made less money, and therefore may have a reduced ability to, for example, pay dividends. That, of course, affects the stock’s value; and today’s earnings affect tomorrow’s share price.
CFOs need to prioritize currency exposure management because investors know that if a company has FX impacts greater than 1-cent of EPS, the company is not managing currency risk to the market standard, and is therefore likely to have continuing FX surprises. That uncertainty/lack of predictability impacts share price.
How to manage currency impact to less than 1-cent of EPS
Fortunately, managing currency impacts to your preset target – whether it is 1-cent of EPS or lower, or any other well-defined MBO – is possible. It requires the “Three M” approach:
1) MEASURE: Proactively understand currency risk across the entire portfolio (all currencies impacting your financial statements) – accurately, and timely (within a short period of time of when you want to know – typically defined in minutes or hours rather than days)
2) MANAGE: Manage currency risk to the acceptable and pre-agreed level – many companies are looking at this as an opportunity to become currency agnostic, because they understand that they’ll never know where next quarter’s currency surprises will come from (e.g. it could be Venezuela, Cyprus, Argentina, Japan – anywhere)
3) MONITOR: Continuously monitor the FX risk management program, which is easily done via readily available and employable cloud-based technologies
Taking the “Three M” approach not only gives treasurers and FX managers – like the 37 we spoke with at the FX Managers’ Peer Group Summit – the confidence they need to manage currency risk to a preset threshold, but also gives confidence in the results to the Board of Directors, analysts, and investors that are continuously evaluating the share value of the company.