International Treasurer

The Corporate Treasurer's Guide to Global Financial Management

May 1, 1995
Spill over effects
SE Asia: Hedging
Against a Yen Bloc
Central banks in Southeast Asia are said to be
boosting the level of yen in their currency
reserves. MNCs should start contingency plans
for Asia to truly become a yen bloc.
Longer-term yen ri sk
1 A Yen for More?
With yen exchange rate repeatedly breaking
historic highs against the US dollar, more com-
panies should start to look beyond simple near-
term profits (or losses). Instead, they should
look to the longer-term tactical and strategic
implications of their long-yen positions.
Southeast Asia has been a popular pl ace for US
MNCs to do business, because with the doll ar
as the 1egional trade currency, and cl osely cor-
related to the local currencies, they did not
have to manage much currency risk. The situa- 1
tion coul d be changing.
A majority of dol l al' -based MNCs have been
enj oyi ng some revenue benefits from the stark
appreciation of the yen in recent months. Whil e
the recent situation has been positive, there a1e
some areas of concern for the long-run. As mar-
kets await G-7 action and the eventual bottom
Adding yen to reserves
Whil e the components of reserves backing bas-
ket currencies like the Malaysian ringgit and
Thai baht are a closely guarded secret, the1e
are signs that these Southeast Asi an centl"a l
banks are buying up yen to change the mi x of
their currency reserves away from the doll ar.
Asian regional treasurers note that increasing
central bank yen reserves wou ld explain why
yen li quidity has been sapped, despite ampl e
selling of yen by the Bank of Japa n. It al so
would explain recent strength in dol lar-linked
Asian currencies against the doll ar. Thi s has
been seen not onl y in the baht and ringgit, but
in the Singapore doll ar and Indonesian rupi ah.
Asian central banks will have to perform an
interesting balancing act, as they try to manage
the possibl e transition of the region to a yen-
bloc. On the one hand, they want their local
currencies to be reasonabl y in-line with t he US
doll ar, and weak against the yen, i n order to
sustain growth in th eir ex port sectors and
encourage Japanese capital investments.
Thi s mi ght expl ain a rumor in late February
and March of this year rega1ding the potenti al
for a devaluat ion of the baht against the doll ar,
' of the doll ar fall , now is a good time to assess
the tacti cal and strategic currency management
' responses to the yen-doll ar rate of exchange.
Here are some hi ghli ghts based on conversa-
tions ove1 the last week.
Changing hedging approach
1
At first glance, the hi stori c hi ghs for the yen
seem to have had littl e immediate impact on
hedging strategies. Most compani es adjusted
their tacti cs in the first half of 1994-some of
them after wrong-siding the market by protect-
ing budget rates of 120-1 30 yen to the doll a1
aga inst expected greenback appreciation.
Few have changed thei r hedging appmach
dramaticall y. Yet, on the back of hi stori c yen
hi ghs, treasu1e1s are looking at ways to lock-in
today's currency value on long yen positions.
Several compan ies say that they al so wi ll be
looking to do this as far out as they can, per-
haps further than thei r normal hedging pattern.
Some are still bound by the soon-to-be-over-
haul ed hedge accounting ru les: "We are look-
' ing to hedge out as far as we can and still get
hedge accounting," notes one treasu1er.
to conceal its increasing yen component. The
ringgit, whil e strong recently, has al so been
talked down, due in part to politi cal uncertain- '
ty surrounding elections. Thi s may be the on ly
A plus for options. According to Jonath an
Berg, managing di1 ector w ith KB CLmency
Adv i sors in New Jersey, many compani es
l ea rn ed th eir l esso ns about the va lu e of
opti ons-based st rategies last yea r. Using for-
wards to l ock-in budget ed exchange rates,
continued on back page continued on page 2
SE Asia: Hedging
Against a Yen Bloc
Asian central banks
look to manage the
trans it ion to a yen-
bl oc.
page 7
A Yen for More?
Apparent structu1a l
changes in the yen-
doll ar exchange rate
have MNCs reeva luat-
ing their longer-term
FX exposure.
page 2
Transferring
Yen Profits
An aggressive posture
by US and japa nese
tax authoriti es ca ll s
for carefu I transfer
pri cing, including the
management of FX
ga ins (or losses).
page3
A Basle Accord for
Market Risk
Proposed BIS stan-
dards for banks to use
internal models to
ensure minimum cap-
ita l gives corporates
new benchmarking
guidelines.
page 4
VaR & Corporate
In-house Banks
Central to the Basle
proposa l, corporales
may conside1 using
value at risk as a tool
to formall y capitali ze
treasury activiti es.
page 5
Benefits from
"Road Shows"
Investment in compre-
hensive p1esentat ions,
demonstrat ing finan-
cial strength, is money
and time well spent.
page 6
Yen Risk
continued from page 1
they were not abl e to part1 c1pate in
any upside when the doll ar continued
to fa ll through 1994 and not recover as
anti cipated.
"Balancing your assets and li abiliti es
i s th e fir st step," recommends Mr.
Berg, "and don' t focus on pi cking the
doll ar bottom." A lot of compani es did
not do as well as they could have last
year, he notes, " because they kept try-
i ng to pick the bottom of the doll ar.
Meanw hil e, compani es that bought
options and left their yen positi ons on
have done rather well. "
While opt i ons are quite ex pensi ve
now, Mr. Berg admits, " in qui et mar-
kets, and for the longer term, options
are th e r i ght way to go." In other
words, look for opportuniti es to buy
sli ghtly out-of-the-money options with
str ikes set for the doll ar to ri se, pur-
chasing progressively more out-of-the-
money options to cover ant i cipated
transactions further out in the future.
Not all compani es would necessarily
wa it for l ow vol ati lity periods, and
hence cheaper option premiums. " It
has been a very long time since we
have seen single-di git vol atility in 12-
month options," says one international
treasury manager, "and given the size
of our business in j apan, and 2-3 yen
moves intraday, the potential financi al
impact of an adve1se yen-doll ar move
sign ifi cantly outweighs the costs of
paying up for volatility. "
While most companies would wel-
come the sight of volatilities coming
down a couple of percentage points at
the long end of the options curve,
they should consider carefully the
costs of waiting compared to the addi-
tional premium they will need to pay
up front.
Pricing negotiations on the business side
Many treasurers note that the most visi-
ble impact of the hi gh-yen situation has
been in negotiations on the operations
side. The most pressing negoti at ions
clearly have been focused on replacing
yen-based sup pi iers with those operat-
ing from weaker currencies.
2
Japan's middl e-market compani es in
the intermediate stages of the value
chain have been hit the hardest by the
yen's appreciat ion. Compani es operat-
in g in and out of Japa n are bein g
forced to source elsewhere, and many
japanese firms w ill need to finally
come to terms with the cultural impli -
cations of movi ng operati ons offshore.
Cheaper imports are vita l to many
japanese firms' weathering this excep-
tionall y strong yen period. Hence, the
second set of negot iations must take
pl ace w ith j apanese customers, who,
knowing full well that translated earn-
ings are boosting the bottom line back
home, are asking for pri cing conces-
sions from foreigners pricing in yen.
The same is true for group affi I iates
in japan, who are trying to 1enegoti ate
intercompany pricing arr angements.
Transfer pri cing and tax pl anning com-
plicate these negoti ation s (see p. 3).
These and pmtectioni st issues lead to a
situat i on where some products and
commodity inputs are pri ced hi gher in
Japan, independent of the FX rate.
Some j apanese affili ates and cus-
tomers may use the currency apprecia-
tion as an excuse to try to negotiate for
the off-shore pri ce.
Currency of billing is a crucial fea-
ture of all these commercial negoti a-
tions. Asi a's treasurers at US MNCs
shou ld put the word out to affiliates
about the currency 1isk impli cations of
changing invoic ing currencies, both
positive and negat ive. " Peopl e in the
fi eld often mi sunderstand the connec-
t ion between the payment currency,
the pri cing currency, and exchange
exposure," notes one Singapore-based
regional treasurer.
For exampl e, he had one affiliat e
manager come to him asking that pri c-
ing be shifted from being denominated
in doll ars to yen, which wou ld all ow
the affili ate to raise pr ices to Japanese
customers. The affili ate manager did
not real ize that whi le receiving pay-
ment in yen is no probl em, changing
the pricing currency to yen shifted yen
exposure to him.
With talk of Asi a- Pacifi c becoming a
yen bloc, there will be pressure to con-
sider swi tching pr icing from doll ars to
yen. " A lot of compani es w ill have a
knee-j erk reaction to switch pri cing to
th e hard er currency [i. e., the yen],
notes I<B's Mr. Berg "and just about
the time that they do, the market may
finally reali ze that the doll ar's decl ine
is overdone and it w ill soar toward the
end of the year." These compani es will
be on the wrong side of th e market
(perhaps again).
Whil e most compani es acknowl edge
that the yen wi ll increasingly become
a factor in Asian regional trade, few
have noticed a major switch to yen-
based pricing. On the other hand,
many are aware that Southeast Asian
basket currenci es like the Thai baht
may tend to trend more toward the yen
and apprec iate aga in st the doll ar,
especiall y if the period of yen strength
looks to become prolonged (see relat-
ed story on p. 1 ).
The strategic currency implications
Because so many multinational s com-
pete w ith j apanese co mpani es,
responses to a pot enti al structura l
change in the yen-doll ar exchange
rate, as well as countermoves by yen-
based compet itors, become a compa-
ny-wide strategic initi ative. With the
yen, then, the currency implications of
doing busi ness internationall y take on
an especially hi gh-l evel significance.
Several US-company treasuri es, in
industries with strong j apanese compe-
tition, report unusu al " multi-hour"
meetings with CEOs and senior man-
agement. Whil e these meetings create
extra work for treasury in researching
an appropriate company response,
they clearly benefit the company . As
one international treasurer notes, " to
the extent that you can get peopl e- as
hi gh up as you can- to think about
the impact currencies have on the way
you operate th e business, you are
adding value to the organization. "
It can' t hurt for treasurers to take the
opportunity, w ithin the context of such
meetings, to hi ghlight their functions'
value to th e underlying business in
other areas and in other currencies. -
Internati onal Treasurer/ May 1, 1995
The Back Page
continued from page 7
reason why it has still been trending with the
US doll ar. Even Singapore has expressed con-
cern about the ri se of its doll ar relative to the
greenback.
On the other hand, those countri es that have
been fi nancing exports through the j apanese
Export- Import Bank or received development
loans in yen face hi gher debt-service costs.
j apan has refused to renegoti at e these yen-
denominated loans.
Purchases of yen, therefore, may be merely a
means to hedge their loans against the prospect
of the j apanese currency climbing still hi gher.
In an April 19 press statement, Bank of Tokyo
President Tasuki Takagaki warned monet ary
authoriti es in Asia that the yen would indeed
continue to ri se and that they shoul d draw up
measures to guard against exchange rate fluc-
tuations.
Some j apanese compani es are not exactly
unhappy w ith the pros pect th at Sout heast
Asian countri es mi ght be losing some of their
currency advantage in order to pay back yen-
denominated loans (see p. 2).
Finall y, there are specul ators, who need to be
kept off-bal ance rega rdin g th e direct ion of
local currencies.
Choppy waters ahead
The j ury i s sti ll out on whether Asia is now
poised to go all the way to becoming the yen-
bloc region many anti cipate. What will happen
if the doll ar starts to app1eciate against the yen
as the year pmgresses, is an equall y uncertain
question. Mi ght reserve baskets weight them-
selves back doll arward? No one reall y knows.
International Treasurer
The Corporate Treasurer's Guide to Global Financial Management
I
!
What is certain is that there is more potential I
exposure, more ri sk, for compani es doing busi-
ness in Asia. Volatili ty and correlati on matrices
for FX as well as interest rates should continue
t o refl ect wavering dec i si ons by moneta ry
authoriti es, whether to adjust t o a struct u1al
strong-yen, weak- doll ar system, or merel y
hedge against such a development as they wait
for a lasting doll ar rebound.
Specul ators will also be contri buting, as they
look to bet one way or the other, both on the
yen, and on yen/ Asian cross rates. Asian central
banks, looking to conceal their hand, will be fur-
ther contributing to market uncertainty.
Gi ven the strategic importance of business i n
thi s part of the world, MNC treasurers would do
best t o focus on the l ong-term compet i t i ve
impacts of the doll ar' s relative value i n Asia,
i nc luding and exc luding j apan. Thu s, th ey
should carefull y examine the currency impli ca-
tions of long-term sourcing and sit ing decisions,
for themselves and Asian compet itors.
In the short-term, choppy waters suggest not
leaving posit ions needl essly exposed to passing
market currents. Al so, worth attenti on is:
the potenti a I fo 1 i nterm itt en t interest rate
spi kes (up or down) and even FX controls.
changi ng trends in the currency of billing
used i n intercompany and thi rd-party trade-
watch out for local moves to yen invoicing.
making assumptions regardi ng an equili bri-
um point for As ian currencies (important for
future budget rates)- i .e., some unknown rate
whi ch provides enough competi tiveness to local
export sectors, without the potenti al for a whole-
sa le liqui dati on of local assets, and suff i cient
debt servi ce coverage in yen terms.
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International Treasurer/May 1, 1995