Companies ponder the urge to hedge by SFC Associates

Companies ponder the urge to hedge; concern over the equity line renews some interest in currency hedging. - American Banker | HighBeam Research

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Companies ponder the urge to hedge; concern over the equity line renews some interest in currency hedging.

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American Banker May 17, 1985 | Weiner, Lisabeth

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Companies Ponder The Urge to Hedge Concern over the equity line renews some interest in currency hedging. THE CHANGE IN accounting laws in 1981, allowing foreign currency adjustments to be reflected only in the equity number rather than current income, has resulted in substantial deteriorations in the equity position of some multinational companies. And while some accounting experts are arguing for companies to return to the more conscientious foreign currency management that existed under the old rules, corporations for the most part are slow to move in that direction. The thinking behind many companies is that the loss or gain from foreign currency translation is now a paper figure that shows up on the equity line of the balance sheet. And companies are reluctant to use cash to hedge what is essentially a problem on paper. Additionally while the dollar is currently strong and appears as a debit to equity, the cyclical nature of currency movement could result in a weaker dollar at some point and the result of that could be a credit to equity. In an effort to reduce the impact that volatile foreign currency translations had on earnings, the

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Financial Accounting Standards Board introduced rule 52, which takes the adjustment to the equity line. Previously, under FASB 8, foreign currency adjustments were added or subtracted from net income. With the effect of the strong dollar over the last three years, earnings currently look better but equity has deteriorated. For instance, foreign exchange translations have had a cumulative negative impact on IBM of

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$2.9 billion from 1981 through the end of 1984, Colgate-Palmolive has been negatively impacted by $260 million through June 30, 1984, and Union Carbide by $357 million, also through June 30. Under FASB 8, companies did must more in the way of hedging in order to reduce the foreign currency translation impact, so earnings would look better to shareholders. Experts generally

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believe that once the accounting rules were changed, the motivation for hedging was basically eliminated. And they also generally agree there is no single answer on whether companies using FASB 52

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today should hedge foreign currency in order to lessen the impact of currency adjustments on www.highbeam.com/doc/1G1-3777053.html

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Companies ponder the urge to hedge; concern over the equity line renews some interest in currency hedging. - American Banker | HighBeam Research

the balance sheet. Today, companies are "relying much less on forward contracts and other hedging tools to account for translation gains or losses,' said Professor Thomas Evans who teaches accounting at the University of South Carolina. They adopted a "problems over' mentality, he said, meaning the problem of foreign exchange is over. Initially that appeared to be true, Prof. Evans said, but that's not so clear any more. "Should it erode equity, companies might find a need to manage foreign currency. A lot of it depends on what happens to the dollar,' he said. For instance, "if the dollar softens, it could become a credit.' Prof. Evans has been commissioned by the FASB to do a study on how multinational companies are meanging foreign exchange risk under FASB 52. And while it is too early to tell what that study will show, Prof. Evans said his preliminary hypothesis is that most compenies do not think it is a good idea to use cash flow in order to improve a paper accounting item. Corporations don't mind letting the negative effects of foreign currency translation show up in equity because "nobody pays much attention to it.' But at least one expert believes that companies that have downplayed foreign currency risk management since the inception of FASB 52 are now getting concerned about the equity line. Ezra Zask, vice president and manager of foreign exchange management services at Manufacturers Hanover Trust Co., thinks companies are starting to show renewed concern for hedging. "Equity is still important because of the debt/equity ratio. Also Wall Street and bankers will look at it,' he said. A deterioration in the debt/equity ratio could be particularly important to a company that must keep the ratio at a certain level as part of a debt covenant. Also rating agencies have said they are putting more emphasis on the equity level in evaluating a company's overall posture. But more companies, Mr. Zask said, are at least looking at hedging on a selective basis, especially in those areas where it has its largest and most valuable exposure in a foreign currency. Mr. Zask is seeing more companies trying to find some natural hedges with which to manage their foreign currencies. This would involve matching assets and liabilities such as creating some kind of long-term borrowing in a local currency that matches an existing debt. "There is gaining use of financial instruments like foreign currency swaps, long-dated forwards, regular forward contracts and options,' he added. No trend on the issue appears to exist. William Hauworth of the accounting firm of Arthur Andersen and Co. said a lot of companies believe if they try to hedge they may wind up with out-of-pocket cash expense. "They don't want to create the risk of spending cash in an attempt to hedge. Some others [companies] are getting concerned about the decline in equity,' he said, adding "It's getting big enough where they are considering some hedging techniques.' But Mr. Hauworth explained, a company's decision to get involved in foreign currency management may depend on what countries it has exposures in. If it has subsidiaries in Europe where there is at least some possibility that the dollar will weaken against other major currencies, then the effect on the balance sheet could in time work itself out. If, however, a company does business in a country that has a weak currency and is not affected by hyperinflation, then hedging may make sense, he said. Colgate-Palmolive has decided that from its perspective hedging foreign currency doesn't make sense. Hans Pohlschroeder of the corporate treasurers office explained Colgate has a policy that requires it not to spend cash for any accounting exposure. "We cannot incur an expense for a noncash item.' The company's particular position just doesn't make hedging attractive. "If we were in a www.highbeam.com/doc/1G1-3777053.html

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Companies ponder the urge to hedge; concern over the equity line renews some interest in currency hedging. - American Banker | HighBeam Research

borrowing mode then maybe you could argue for it,' he said. Additionally, Mr. Pohlsheroeder believes the financial community understands how Colgate does business, so the paper loss doesn't mean anything and the fact that it doesn't hedge is not frowned upon. COPYRIGHT 2009 SourceMedia, Inc. This material is published under license from the publisher through the Gale Group, Farmington Hills, Michigan. All inquiries regarding rights or concerns about this content should be directed to Customer Service. For permission to reuse this article, contact Copyright Clearance Center.

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