Macro Moves & Corporate Perspectives – Geographic differences in multinationals’ foreign exchange assessments
I have been in the foreign exchange business for over a decade, helping businesses with revenues of a few hundred thousand to publicly traded multinationals with 11-figure top-lines. Every business is different. Even companies in the same industry may have completely different FX exposures, planning and processes.
That said, as I have expanded my scope beyond Canada and North America to the United Kingdom, European Union (EU), and Mexico, broader patterns emerge in how businesses view and address foreign exchange. The biggest fault line I have identified is between the United States and the rest of the world.
The Macro Matters
Smaller open economies like Canada, Mexico, the United Kingdom, and Australia tend to have a far greater proportion of their economies oriented around global trade than the United States market does. Intuitively it makes sense: the US is a massive market. There are a lot of places where US firms can sell before they are constrained by internal market size.
Chart – percentage of GDP (Gross Domestic Product) composed by foreign trade. Canada, UK, Mexico, United States (TK)
Consequently, US businesses with material FX exposures tend to be larger than their Canadian, Mexican, or British counterparts. For example, it is not uncommon for Canadian businesses with CA $5-10 million in revenue to see much of their revenue or Cost of Goods Sold (COGS) denominated in a foreign currency. In my experience, outside of the Business Process Outsourcing (BPO) or manufacturing outsourcing space, US businesses with material FX exposures typically have top lines exceeding US $50M.
Outside of trade, there are a few factors that contribute to this:
Primacy of the USD. When your functional currency is the world's reserve currency, you (rarely) need transact in anything else.
Hidden FX exposures. Larger businesses are more likely to have ‘hidden’, or unrecognized, FX exposures. (We will dive deeper into this in our next piece, focusing on the FX lifecycle.)
Finance Team Perspectives
Now we know the macro matters driving differences in perspective between US firms and the rest of the world. But what ARE the differences in perspective?
The biggest can be categorized as a difference in focus: one on the cash flow and performance relative to the budget impact of FX risk, and the other, a focus on the balance sheet impact of FX risk and how this remeasurement gets pulled into non-operating income.
Rest of World
Greater awareness of FX exposures. This potentially can come down to a very granular level by day, vendor, and currency type.
Emphasis on cash flow hedging. This focus may be due to a few reasons.
They are less likely to be dealing in their functional currency, especially when dealing cross-border.
They have more forecastable cash flows with an FX component. This FX component is generally a bigger proportion of the overall cash flow; and mathematically it is easy to see how prospective variations in FX rates are going to impact their planning, margin, and working capital.
Take the example of a Canadian tech firm invoicing in USD: It is not unusual to see businesses in this sector with well over 50% of their revenue in USD. They don’t need to go through extra steps to break out the FX from domestic revenue: they KNOW it’s there.
In this situation, generally, their selling, general, and administrative (SG&A) expenses are entirely Canadian. Thus their operating income is substantially impacted by movements in the USD because they must convert currency to cover their operating expenses.
The chart below, from the Bank for International Settlements (BIS),illustrates the prevalence of the US dollar in international trade
In short: the United States accounts for ~10% of international trade, but the US dollar is used to settle just under 50% of international trade.
The United States
Balance sheet perspective. In contrast, in the US FX tends to be viewed from a balance sheet perspective first, for a few reasons that are quite interesting:
US businesses with material FX exposure tend to be larger, and this exposure may emanate from foreign subsidiaries with separate financials.
There is a tendency amongst many US finance departments to push the FX risk onto their subsidiaries, settling inter-company transactions in the functional currency of the parent. This leads to a few outcomes.
FX exposures become far less visible when held at the subsidiary level. The only time the impact of FX movements is evident is on consolidation, or when the foreign subsidiary starts seeing their margins tightening due to higher USD. Given the strength of the US dollar in the last 18 months, this has been happening to a lot of businesses.
Limited visibility into FX at the parent company level. Parent companies with material direct cash flow exposure to FX may still have limited visibility:
The FX portion of cash flow may not be broken out, and thus not discussed or considered in the budgeting process.
Without a non-USD account, businesses receiving FX would see funds automatically converted to USD. This could result in higher conversion or transaction costs and less control. As an example, I once saw a business receiving 20M euro a year into a USD account--and paying 3% for the privilege.
Thus with these ‘blind spots’, or lack of awareness, US finance teams tend to place a greater emphasis on balance sheet FX exposures and managing the implications of these exposures. In my opinion, a lot of this could just be because it’s the best-quality data that they have.
There is a reason for this. In our next piece, we will dig deeper into the FX lifecycle, and how it relates to a business’s financial reporting, budgeting, and visibility of FX exposures on their financial statements.
Read the next article in the series: The FX Lifecycle Explained
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