International Treasurer

Time to Blame FX?

By Joseph Neu

Long-term doll ar
st1ength has given ri se
to quali fying statements
regarding foreign earn ings-bu t nothin g gets
said about hedging.

The Journal of Global Treasury and Financial Risk Management

April 28, 1997 http ://www.intltreasurer.com

page 7

Corporate earnings

Euro w atch

Time to Blame FX?

Keeping Tabs
on EMU Scenarios

By joseph Neu
With the dollar's steady rise over the last two
years, US MNCs can now use currency losses as
a plausible excuse for lower earnings. What does
this say about hedging?

We' ve come to another point in the cycl e where

a prolonged period of dolla1 strength mi ght be
expected to cut into US MNC's earnin gs . W e
know that some companies are hed ging thi s
impact, but we don't rea ll y know for su re how,
and may never come to, even with pressures for
more disclosure.
Simple/effective vs. complex/revealing. G iven
the simp li city of the argument that the same fmeign sa les trans late into lower doll ar eamings as
the dollar rises, citing cunency effects is a convenient card to play in the game of W all Street
ea rnin gs expectations. "B lamin g the dollar," for
example, looks to be currently in vogue w ith
pharmaceutica l f irm s (h ighl y dol lar sensitive).
See for examp le, these recent eam in gs re leases:
Pharmacia & Upjohn: the Swed ish-U.S. ph armaceutical company 1eported that sa les for th e
continued on back page
1.8 0 . - - - - - - - - - - - - - - - - - ,
1.70

USD/DEM (4/1/94 to 4/23/97)

1.60
1.50
1..10

1.30
1.20 . . __ _ __

_ _ _ _ _ _ __.J

1 3 0 , - - - - - - - -125
12 0

------,

11 5
1'1 0

l'

USD/)PY (4/1/94 to 4/23/97)

(.I'

f!V?

105
100
95
':)0

85
80"----~-------~

Scenario planning for EMU: keeping an eye on

the big picture during the rocky May/June period.

Re ce nt vo lat ility in EMU pwgnost icat ion s is

unlikely to subside. Between now and june, we
have the French general el ections, German fi sca l
repo1is, the UK elections, Itali an municipal election s, and a potent ial US interest rate hike to
contend w ith . Still , some of the optim ism lost in
recent months is beginning to return.

Sources of optimism
News of German Chance llm Kohl ' s standing for
reel ect ion and the bo ld dec ision by French
Presid ent Chi1ac to ca ll for elections 11 months
ah ead of schedul e have boosted seve1al prognoses. Based on these items, SBC Warburg, for
examp le, has changed its view on the probability
of EMU sta1iing on t im e back up to 70:30. It had
dmpped to 60:40 from 80:20 in March on word
of d issatisfaction in German y with the extent of
the Eurostat's (the EU statistica l body) allowances
of accounting trickery.
"Th e French election announ cement is parti cularl y good news for Ita ly," notes M arc Hendriks,
man ag ing d irector of econom ic research for SBC
W arbu1g in London , and wi ll br in g va lu e to
Itali an assets. France has been a champ ion for
ea rl y EMU e ntr y fo1 It a l y and t he ot he r
M editerran ea n countries as a counterbalance to
German EMU dom in ance. Ita ly' s participation is
see n as cru c ial to th e su cce ss of EMU on a
broad er scale (see IT, 10/28/96).
Itali an Pr ime M ini ster Romano Prod i, like
man y ot her Europ ean leaders , has staked his
po litical reputation on EMU. The scenario everyone is look in g at is whether Ita ly wi ll (1 ) make
the cut for first round entry on 1/1/99 or (2) that a
face savin g dea l can be struck (for Germany' s
benefit) to have Ita ly jo in sli ghtl y later.
An election w in by Ch irac's pro-EMU coa lition
of moderate ri ght w ing parties and the Socialist
continued on page 2

Keeping Tabs
on EMU Scenarios
Recent events have
buoyed optimism, but
the next two months
w ill be rocky. Best to
sti ck w ith the major
long-run outcome scenarios rather th an the
interim "what-ifs."

page 7

Understanding FX
Settlement Risk
Wh y bank regul ators
are so concern ed about
FX settlement ri sk, and
how to determin e if you
should be.

page2

Cerg Finance
Eyes America
Thi s French cash management and electroni c
banking system vendor
is one of many foreigners w ith eyes fo r
A merica.

page 4

China After
Hong Kong's Return
By Henry l ee Cha n

Assessing th e situ ation

of Greater Hong Kong
and th e Hong
Kong/China Symbiosis
w ith tw o month s to go.

page6

Accounting & Disclosure

Editor & Publisher

Josep h N ell

Cont ributing Editors

"Time to Blame FX?" continued fro m front page

Hal Davis
Donald Dunn

first quarter ended March 31, 199 7 were 6%

below the same period in 1996. A sign ific ant
portion of the shortfall was attributed to "continued negative exchange-rate developments."
Bristol-Myers Squibb: "Sa les for the quarter
grew 10% (12% exc ludin g the unfavorable
effect of foreign exchange) .... Domestic sales
increased 11%, and international sales
in creased 9% (14% excl uding the unfavorable
effect of foreign exchange) ."
Eli Lilly: " Internation al pharmaceutical sa les
decreased 5% with volume growth of 6% being
offset by an 8% unfavorable exchange rate comparison and a 3io reduction in sellin g prices.
These statements are not necessarily false. But
they may not represent the rea l eco nomi c
impact on earnin gs for the given quarter.
Ferret in g this out wou ld req uire a ca reful
ana lys is of each company's currency exposure,
in cluding the indirect impact of FX moves on
non-FX exposures and competitors. This analysis is mu ch more co mpli cated than most equ ity
ana lysts would care to get into, and much too
revea lin g for most co mpani es to disclose. And
this assumes they have a good notion of these
rea l impacts in the first place.
Another way around this, as we noted last
issue, is seen in the technology sector. In IBM's
1Q ea rnin gs release, we see thi s linguistic tool
at work: "On an as-reported basis, first-quarter
revenues in North America were $7.9 billion,
an in crease of 14% from the same period a year
ago. Asia-Pacific revenues increased by 3% to
$3.4 billion while revenu es from Latin America
were up 2 pe rce nt to $701 million. Revenues
from Europe/Middle East/Afri ca declined by 7%
to $5.3 billion. On a consta nt currency basis,

Asia-Pac ific revenues grew by 14% and Europe/

Middle East/Afr ica revenues grew by 1% ."
What is treasury hedging for? Si nce currency
effects are useful in explainin g earnin gs shortfa ll s, there seems to be little incentive to put currency mana geme nt pr actices and earnings
reporting on more rea l is tic econom ic terms.
Thi s begs the q uest ion of how much va lu e
hedgi ng adds if shareho lders are un aware of
it -i.e., if a tree falls in the forest and no one's
there to hea r it, does it make a sound?
A lso, impli c it in statements about currency
impacts is the notion that currency ri sk is uncontrollable . Thi s co ncept fits the US Private
Securities Lit igation Reform Act of 1995 con ce rnin g "forward- looki ng" information. Many
compan ies' 10-Ks now include currency fluctuations in a li st of items said to be beyond their
contro l and w hich cou ld materially affect future
results. This is a kind of discla imer to avoid litigation when results indi cated by "forward -lookin g" statements made by company agents, or
forecast information released to t he public, are
not realized (see Compaq, IT, 5/16/94) .
Such disclaimers also work to impl y that hedging is less than a positive sum game.
Co mp ani es that engage their treasuries to
hedge presumably believe otherw ise. Some way,
some how, the value of hedging must show up
in f in anc ial reporting . To say "the company is
active in va riou s fo reign exchange markets to
hedge its econom ic and transaction fo reign currency exposures" (as recommended by the FEI,
see IT, 11 / 12/94) is nowhere near enou gh to
imply to shareholders that value is being added.
This is yet another reason to view t reasury
activities as costs to be cut

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Intern ational Treasurer/April 28, 1997