Joseph Mariathasan: Share holders and currency exposures
Joseph Mariathasan looks into how companies should trade currency in what looks set to be a volatile year
The start of a new cycle of rate rises in the US, together with a weakening renminbi, suggests 2016 should see plenty of volatility in the currency markets. How should companies trading internationally react to this?
One of the issues I was once asked to examine when I was running a treasury function before the introduction of the euro was the currency hedging strategy for the management of the balance sheet of the insurance company I worked for.
There seemed to be a lot of confusion as to what the objectives actually were (I suspect not a lot has changed since then). When I approached the subject by having detailed discussions with a range of international banks and insurance companies on what their policies were, I found the results were certainly not what I expected.
The answer was usually very clear for US banks and insurance companies – all net exposures to overseas assets were hedged back into US dollars. Indeed, the question itself was seen as an odd one to ask. But when I asked a UK or Dutch bank or insurance company the currency distribution of their shareholders funds, the answers were often very different and frequently incoherent. Many responded that the distribution was spread across a range of currencies, reflecting the range of international business exposures the company possessed. One major bank admitted it had changed its policy a few times over the previous decade.
Why should the US financial institutions have such a very different attitude to Europeans? There is no theoretical reason why one currency benchmark should be preferable to another in an era of international ownership. And there is certainly no reason why US institutions should have a different policy to European ones.
The answer must be cultural. The growth of US financial institutions occurred predominantly within a domestic environment during the 19th and most of the 20th centuries. For most of the history of share ownership in the US, shareholders never see foreign currency exposures, and, as a result, any international forays were automatically hedged back into US dollars.
In contrast, the growth of capitalism within countries such as the UK and the Netherlands has been associated with the growth of international empires, where foreign currency exposure was an inevitable part of investment activity, both by trading companies and by the banks and insurance companies that supplied services to them. What that meant was that shareholders of the international banks such as HSBC and the insurance companies that spread across their old colonial empires were used to seeing exposures to foreign currencies. Their strategy of international exposure, with the foreign currency exposure it implies, has continued into modern times.
The problem we faced then was that, while having a broad exposure to foreign currencies can be a perfectly acceptable theoretical approach, not having a clear benchmark had some negative side-effects. Valuable management time was wasted by asset/ liability management committees taking currency positions that become bets when successful and hedges when not. No doubt, a fun time was had by all in switching some currency positions at a committee meeting after a decent lunch, but, with no clear benchmark, there was also no clear measurement of performance or of any value added by the exercise.
The answer lies in companies having a definite position as to where an asset/liability committee can add value, and if it is not in taking currency positions, they should adopt a precise benchmark, announce it publicly and stick to it, allowing their shareholders to take currency bets elsewhere. But when I suggested that as the solution, that idea never took off – it would have removed the after-lunch bets that the committee liked to take once a week.
Joseph Mariathasan is a contributing editor at IPE