From the February 2008 issue of Treasury & Risk magazine

Dollar Dynamics

Q: What does the weak dollar mean in terms of FX-related accounting and exposure management practices?

A: The weakness of the dollar has meant windfall profits for most U.S. companies. These financial results, while positive on the surface, have served to obscure some very common problems about how companies manage multi-currency accounting and foreign exchange risk. Simply put, there are many multinational companies out there who simply have not accurately quantified their foreign exchange exposure. Today, with the weak dollar, that's translated into unanticipated profits. When (and not "if") the dollar begins to rise, those unanticipated profits will turn into unanticipated losses. To blame these losses on the vagaries of foreign currency volatility is simply unacceptable.

Today, unanticipated corporate profits are raising some tough questions by boards of directors, investors and analysts, such as "What part of the company P&L actually is planned and what part is dictated by the currency market?" Any complete answer to this question from the CEO and CFO and their organization should describe how foreign exchange is measured, managed and monitored. These constituencies want to see clear control and economic predictability. If the company can't succinctly state the FX exposure and actions taken, compliance questions should follow. Experts in the field, including FiREapps, have seen more fundamental questions asked by corporations about foreign exchange exposures in the past three to six months than they have seen in the past seven years. While profits from the falling dollar have initially inspired many stakeholders to celebrate, they will not be so gleeful when foreign exchange volatility forces companies to deal with accounting, compliance and the inevitable unanticipated and unbudgeted losses.

Q: What will the fallout be for companies if volatility stays high and/or the dollar reverses?

A. Increased volatility has already caused uneasiness in treasury departments. Unfortunately, many CFOs don't recognize that they are setting their treasury up for failure as this very difficult challenge does not just rest on the shoulders of the treasury. While the CFO looks to treasury as being responsible for any foreign exchange gain/loss they forget that the treasury is only as good as the data they receive from the controller's area. While there is much historic data to support a bottom of the dollar, even a sudden unsustained rise in the value of the dollar will cause many companies negative surprises and will lead to specific questions for CEOs, CFOs and controllers about the exposure definition process, the institutionalized actions as well as the risk the company is managing towards. The result will be audit firms finding FAS 52 and cash forecast issues that will be very costly for corporations. U.S. companies will experience what many European, Canadian and Asian companies have experienced in the last few years: questions about shareholder value, lack of controls and process resulting in significant competitive and market cap losses.

Q: Will increased volatility translate into increased scrutiny by regulators?

A. Increased volatility especially as Q4 results are released will surface significant surprises. The fact that foreign exchange G/L had not been planned for or predicted will make investors nervous and put decision makers under increasing scrutiny. The sequence is always the same. Economic surprises cause regulatory scrutiny. The increased scrutiny will have two effects. The first is audits of processes around existing regulations. The main focus will be FAS 52 as these are recognized as being known numbers and how can anyone get known facts wrong? The second is a change in disclosure requirements. Today's disclosure requirements are fulfilled by only disclosing the derivative products companies are utilizing to reduce risk. In less than 1% of cases do they actually reflect a company's true FX risk exposure. Informing investors of the derivative products that the company has at a specific time only discloses one side of the risk equation. When the surprises begin to surface, reporting requirements will increase requiring companies to disclose the foreign exchange exposure of the company, the derivative products they are utilizing to reduce the risk, and the net risk that the company has.

Q: What should multinational companies do today to protect themselves from foreign currency volatility?

A. They need to take a closer look at the people, process and systems that comprise their foreign exchange exposure management strategy. If a company wants to avoid FX-related surprises, the board and C-level executives need to send a clear message that getting foreign exchange right is important to the firm and as such will be properly supported. Company leaders need to support greater collaboration throughout the organization to better understand and manage the root causes of foreign exchange exposure within their organization, so that it isn't simply something that's dealt with after the fact. There are many interlocking pieces to this puzzle, and it really requires that functional managers within the finance organization step out of their silos to understand the cause and effects of their actions with regard to foreign exchange. That collaboration should lead to a better definition and application of processes that can then be institutionalized and supported by automated systems that deliver a timely and accurate depiction of the company's exposure on demand.

The end result should be an automated process that provides greater visibility into the FX exposure management process in a way that is easy to administer and maintain. That process should include automation of decisions that ensure policy compliance. By automating all of these phases of the process, companies can ensure that once the problem is fixed, they don't find themselves in the same position again.

Koester is the CEO of Rim-Tec Inc., an Arizona-based company that developed a foreign exchange exposure management solution at its FIREapps subsidiary.

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