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Insight to All Things Currency and Treasury Management

Since the third quarter of last year, volatility in the Chinese yuan has been roiling global markets, and significantly impacting many corporations’ earnings per share. At the G20 meeting a couple of weeks ago, China promised not to depreciate the yuan, saying “There is no basis for persistent [yuan] depreciation from the perspective of economic fundamentals.”

Given that China’s “promise” was followed by a cut in its reserve requirement ratio – which frees up 700 billion yuan ($107 billion) of capital and is probably as effective a way as any to devalue the currency – the pronouncement was little comfort to the likes of Apple, which recently reported a $5 billion loss due to currencies for its first quarter of 2016. (In the last week the yuan had a few brief rallies, but none sustained and overall the yuan remains volatile.)

Volatility caused by yuan surprises is not a new topic for us; we’ve been talking about it since 2012 (as in this blog post, Themes We’re Watching in 2013: How Will China Liberalize the Yuan?). Late last year, when Morgan Stanley suggested that 2016 would be “Yen Year” I explained in CFO Magazine why I believe “Yuan Year” will turn out to be a much more apt characterization – and how popular consensus that a free floating yuan would appreciate might turn out to be very wrong.

Yuan volatility is made worse by three factors: 1) the panic that yuan devaluation tends to cause in global markets; 2) the fact that yuan volatility ripples outward to other currencies; and 3) the fact that the People’s Bank of China (PBOC) has still not mastered the art of communicating with the market, so its moves tend to be surprises.

Yuan impact is intensifying

Many multinationals are highly exposed to the yuan, but many haven’t been actively managing the currency and its associated risks. That was because of its close peg to the U.S. dollar, which meant there was little exchange-rate volatility for companies to worry about. That has changed as China has widened the trading band within which the yuan is allowed to move.

Expect these moves to result in continued and significant financial impact on companies with large exposure to China. Examples of those include American chip-maker Qualcomm, which generates 48% of revenue from Chinese sales; electronics giant Texas Instruments, with 32% of sales coming from China; and even Apple, with 24% of total revenue from China in its most recent quarter.

Yuan volatility ripples outward

Yuan swings also impact other currencies around the world, including elsewhere in Asia and in Latin America. In Asia, yuan volatility is especially impactful on free floating currencies in the region. In 2015, when China widened the yuan trading band, volatility increased among many Asia Pacific currencies as other countries took action to attempt to maintain parity against the yuan.

Another example of yuan volatility creating a ripple effect around the world is Brazil. China is Brazil’s largest export market by far, importing half of all the commodities products that Brazil exports. The real has been extremely volatile – not only because of devaluation of the yuan, but in part because of it. Bank of America, for example, said that a 1% move in the yuan is associated with a 0.5-0.6% decline in commodity prices – which hits Brazil particularly hard.

It is anybody’s guess exactly what ripples will come from this latest bout of volatility. We do know they will bring the investment community and global economy into uncharted territory.

China’s yuan moves tend to be surprises

Whether it is allowing the yuan to drop by 2 percent (as the PBOC did on August 11, 2015) or cutting the reserve requirement ratio, China’s moves tend to surprise the market. That’s different than many other major currencies. Most major currency movements do not “surprise the market” because they are usually predicted/telegraphed via communications into the market from central banks (days prior). China has yet to follow this same procedure with their most recent moves.

For corporate leaders, key is understanding what yuan moves mean for the business

As I wrote recently in CFO Magazine (Gee, 20: No New Currency Deal, China Devalues Yuan), currency volatility is one of the largest manageable financial risks a company faces, and the current market highlights the need for corporate leaders to manage the risk smartly. This is not only a treasury or CFO issue; it should be treated as an enterprise issue.

Effective management comes from the right initial preparation, where risk tolerances and key performance indicators are clearly defined in a risk policy. Creating this policy begins with a complete and accurate snapshot of the currency risk facing the organization, using data provided by the CFO and his or her financial team.

Once policy is defined, CEOs can look to their CFOs on a quarterly basis to deliver a complete and accurate picture of the entire portfolio of currencies where they do business and their associated risk. Then weigh whether performance is in line with policy and the implications of current performance across the organization.

What has changed in the last decade is that while multinational corporations used to focus on managing risk from their largest currency pairs, they are now impacted, potentially, by hundreds of currency pairs. Thus, managing the risk effectively requires a view of the entire portfolio of currencies and risks.

Ably managing the impact of yuan volatility to earnings per share is not only about knowing the company’s exposure to the yuan. CFOs provide access to the answers required to understand how a particular move in a given currency has affected, is affecting, and might affect all aspects of the business, from revenue and expenses to supply chain to net income and cost of goods sold.

In turn, the CEO is prepared with answers when the board wants to know the business and finance implications of the quarter-to-date 5% depreciation of the yuan. When an analyst asks how a 5% depreciation next quarter could affect earnings per share, the CEO has the answer.

Getting from here to there

Getting to the place where the CEO can answer those questions doesn’t have to be difficult, time-consuming, or expensive. As former Microsoft CFO (and Nike board member) John Connors explained last year in a piece for the National Association for Corporate Directors, “Companies now must manage currency risk across the full portfolio of currencies to which they’re exposed, which is complex. But that does not mean it has to be difficult or time-consuming. By leveraging a cloud-based exposure analytics tool, you could have the visibility necessary to become a currency-aware organization by your next board meeting.”