The G20 did nothing last weekend. And that’s really something. Especially for U.S. companies like Apple.
Leading up to the G20 summit, there was hope that world leaders might strike a new currency agreement. But no such luck. Even U.S. Treasury Secretary Jacob Lew, who has for years been pushing China hard to de-peg its currency from the U.S. dollar, seemed comforted by China’s weak promise that “There is no basis for persistent [yuan] depreciation from the perspective of economic fundamentals.”
While the (lack of) news from the G20 was surprising, China’s response was not. Less than 48 hours after indicating no desire to devalue the yuan, on Monday the People’s Bank of China cut the reserve requirement ratio (the percentage of deposits that banks must hold in reserve). The action, which frees up 700 billion yuan ($107 billion) of capital, is probably as effective a way as any to devalue the currency.
This surprise catches multinationals like Apple — which recently reported a $5 billion loss due to currencies for its first quarter of 2016 — off guard. And it isn’t just a China situation. Unfortunately, this global race to the bottom, driven by market-surprising moves and currency manipulation (quantitative easing), feels like business as usual.
Volatility in one currency creates ripples that generate volatility in other currencies. For example, when China widened the yuan trading band last year, volatility increased among many Asia-Pacific currencies as other countries took action to maintain parity against the yuan.
As another example, yuan volatility significantly impacts Brazil (half of Brazil’s commodities exports go to China) and can create volatility in the Brazilian real.
Currency volatility is one of the largest manageable financial risks a company faces, and the current market highlights the need for CEOs to manage the risk smartly. This is not only a CEO issue, as it is a deliberate choice by a CEO to manage currency risk in today’s environment, and frankly 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.
The constituents (and technology) involved in currency risk management has changed a lot over the last decade.
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.”
I’ve said before that 2016 is the year of the yuan. I’ll be even bolder here: China’s currency will be the global finance story of the decade.
One day, the yuan will be a free-floating, globally traded currency. But getting from here to there is going to wreak havoc in global markets. Some corporates will fare well because they’ll be able to explain how yuan volatility impacts their business, and the steps they’ve taken to manage that risk. Others will continue to surprise their shareholders.
Wolfgang Koester is the CEO and co-founder of FiREapps, a provider of cloud-based currency analytics for corporate finance.