When world currencies fall

Asiamoney, October 2011

One of the characteristics of this year’s market volatility has been a decline in the value of three of the four major world currencies – dollar, euros and sterling – and a precipitous rise in the fourth (the yen) and Asia’s local currencies. This creates challenges for Asia-based treasurers around hedging, risk management and even reporting.

Use of hedging has shifted since the financial crisis. “If you cast your mind back to 2007, clients were engaging in some hedging activity, but not on a systematic basis,” says Shankar Hari, regional head of FX, Asia ex-Japan, at JP Morgan. “That has changed completely. Hedging is now looked upon as a very important part of a client’s activity in terms of managing the volatility of their P&L and reporting their numbers.” Products have evolved too, from structured and complex to more vanilla and transparent forms. “But the most important thing is the way people hedge,” Shankar says. “With the enormous appreciation of Asian currencies, people have become more conscious of their exposure to an appreciating local currency versus the dollar or euro, and have taken conscious steps to hedge that.”

This is a widespread view. “Clients generally want to monitor their hedging positions and books, and we are now seeing a lot more interest in active management of their hedging,” says Mahesh Kini, regional head of cash management for corporates, Asia Pacific, at Deutsche Bank.

Methods and processes around currency management do vary from place to place, though. “Most treasurers at larger corporates will have a fairly well defined policy with regard to foreign exchange,” says Ray Zabarte, global head of payments at Standard Chartered. “For the most part, the guidelines will cover things like: what’s the base currency, and how much risk are they prepared to take outside of that base currency?” That makes today’s volatility challenging. “If their base currency is undergoing massive change, a corporate treasurer would need to think about how they reframe their policies or make recommendations to their management team about how they accommodate fluctuations. At one extreme they can convert everything back to their base currency as soon as they can, to avoid any currency risk.” That means analyzing their inflows, any natural hedges, and establishing processes for swift conversion. “Alternatively they may take a view on which currencies are moving which way, and whether that is favourable or not for their organization.”

That’s quite a big call: treasurers are, after all, in a position to benefit from Asian currency appreciation, but is it their job to do so? In one respect, companies need every free kick they can get at such a difficult time. “Corporate treasurers are clearly being squeezed for earnings like never before,” says Richard Brown, Asia Pacific regional head at BNY Mellon. “So bring able to conduct business efficiently across an ever-growing list of currencies is a priority.”

And particular for companies that borrow, there is no shortage of opportunity to take advantage of local currency strength over dollars. “We are seeing significant needs for dollar financing given the interest arbitrage many clients would have,” says Sridhar Kanthadai, managing director and Asia Pacific head of treasury and trade solutions at Citi. “They borrow in dollars because it’s cheaper and because if you have a view on a depreciating currency it is better to borrow in that, as you have a natural gain if you are covered in other currencies.” The combination of its dominance as a trade currency, cheapness, and likely further deterioration stacks up well for the Asian treasurer.

But as Kanthadai says: “Most prudent companies will hedge that, because their job is not to make money on the funds that are underlying the goods and services they provide.” A middle ground is to leave part of the exposure unhedged.

One added complexity arises when a company adds a new currency to the mix – not just the offshore RMB (see box) but newer market such as Vietnam. “If clients are doing hedging based on a fair estimate of their imports or exports in a particular currency it is not too much of a challenge,” says Hari. “But the problems start when they have a hedging policy with a mix of hedging and some open exposures, so they have some portion that is unhedged in various currencies. At that point, they have to start thinking about correlations.” (Introducing CNH – offshore RMB – is still more complex because it has no history of volatility to work with.) And in practice, this approach of partial hedging is by far the most common. “Hedging fully has never happened,” says Hari. “If you think of any Asian company with a good growth story, they always end up underhedging as their final revenue numbers exceed the estimates.”

More frontier currencies represent challenges to treasurers, and banks have been quick to try to fill the gap. “In these currencies that don’t see a lot of volume, we can offer fixed margin products despite the ebbs and flows of the currency, so we can provide them with certainty,” says Zabarte. “It provides transparency that has not been seen in this market before now, and gives the treasurer – and the market – confidence they can enforce their policy. In currencies outside the top 20, margins can be very wide: where the G3 currencies might be a few pips, further down the list you can see 20s, 30s, even 100s in the margin.”

The decline of the dollar has a particular impact for companies who do their reporting in that currency. The reversal in its fortunes has been so intense that it is causing some companies to think about changing their accounting currency, bankers say. “The majority of multinational clients will be reporting their financial results in dollars, euro or sterling,” says Zabarte. “They may well need to reconsider whether or not they should continue to be reporting in that currency. This period of turmoil and volatility could have a substantial impact on their financial performance as it is reported.”

But even if they do, while the dollar has been beaten down, it remains crucially important to world trade. “There is a continuing need and demand for the dollar,” says Kanthadai at Citi. “As a trading currency it has not been dethroned by any other currencies yet. A lot of the commerce is still dollar-based.”

That means that no matter how irksome the decline for companies, there’s not a great deal they can do about it. “For clients who predominantly trade in US dollars outside of the eurozone, it is more difficult to switch to another transaction currency as they have limited alternatives,” notes Shivkumar Seerapu at Deutsche Bank. “If they’re buying from or selling to Europe they can switch to euros, but for any other part of the world – Middle East, Africa, Latin America – the primary currency remains US dollars. Purely from a currency play point of view it might make sense for them to invoice in yen or Swiss francs, but it’s not so easy for them to do so in practice. There are implications for bank accounts, for example, and they also have to convince the overseas buyer or supplier to switch. What’s good for an exporter may not be good for an importer.”

While the movements in currencies do present some challenges, they’re only really part of the broader change in the way treasurers are having to be ever more vigilant around risk. “A lot of corporates over the last 12 to 36 months have been going through a transformation in how they approach risk and cash management,” says Mark Burrough, regional head of treasury services foreign exchange product management at JP Morgan. “While we have seen a shift in the way treasurers operate, we’re not seeing anything new or groundbreaking with the recent emergence of Asian currency strength. They still have the same challenges in incorporating any new currencies into existing operations: how to risk manage those currencies.”Risk, as ever, is key.

BOX: RMB

The Chinese currency is clearly the big story in Asian cash, trade and FX right now, particularly since August when the People’s Bank of China allowed all corporates in the country to conduct payment and receipt in RMB. Naturally, volumes are increasing, although a lot is still done in dollars. “There are two things happening in parallel,” says Burrough at JP Morgan. “A relaxation of rules around settlement, with more companies able to access RMB; and a customer preference moving towards RMB. There is definitely an increasing number of transactions.”

All the cash banks note increasing appetite for RMB services. “Transacting in offshore RMB is becoming increasingly popular for trade with counterparties in mainland China,” says Seerapu at Deutsche. “It is no longer something that will happen in the future; it’s happening as we speak and increasing by the day.” Client interest is focused in Hong Kong and Singapore, he says, with the beginnings of interest from Thailand and Korea. “We notice the bulk of demand is from foreign exporters selling into China wanting to invoice in RMB; we haven’t seen as much demand in the other direction, that is, Chinese exporters invoicing in RMB for overseas sales.”

There is some suspicion about what exactly has driven the growth; cash banks tend to be nervous of any activity that has grown out of trading bets rather than real underlying trade. “You’ve clearly seen a staggering growth in RMB trade between China and Hong Kong,” says Kanthadai at Citi, but he says it has been leveling off. “My understanding is that a lot of the underlying growth is commerce, but the reason it’s denominated in RMB is because of the arbitrage trade they can do around it. If you have a strong view on the RMB, you would probably love to take positions in it.” He says many companies are settling inter-company between their various entities in RMB, and then accessing dollar liquidity offshore using that RMB as collateral. “If you have a strong view the RMB is going to appreciate, it’s a good trade,” Kanthadai says. But because of that arbitrage approach, “I don’t think the staggering growth we have seen is really a pointer of what we should expect to happen in future.”

While arbitrage trades clearly have an impact, Zabarte at Standard Chartered says “we are definitely seeing underlying trade. The types of transactions that are taking place are quite obviously real trade, real business, real flows.”

The RMB involves several practical challenges, particularly since in its offshore form (CNH) it has no history. “There is the information management perspective, but also operational readiness,” says Burrough. “For example, CNH isn’t an official currency. It’s not recognized by SWIFT: you have to use CNY. So distinguishing flows between Hong Kong and China has become an operational issue for clients.”

There’s also nothing like the same potential for hedging offshore RMB as there is for most other big trading currencies. “Offshore RMB for trade settlement is clearly going to become more commonplace,” says Brown at BNY Mellon. “But there is still some way to go before we have the same hedging capabilities as the other major currencies, and that will continue to be a drag on adoption.”

Consequently the feeling at the cash management banks is still that greater use of RMB for clients is going to be a reasonably slow process. “Corporate relationships – buyer-seller, importer-exporter – will gradually be educated on the whys and wherefores of trading in RMB,” says Zabarte. “Clearly that trend is going to find an equilibrium but I don’t think we’re at that equilibrium today. Whether sales contracts are re-denominated in RMB this year or next or five years from now is going to be down to the party involved.”