more-arw search

Q&A Forum

How can I hedge margin on the P&L when we are a multinational company with operations in the EU - thus Euro revenue and Euro sales? (Webinar Attendee Question)

How can I hedge margin on the P&L when we are a multinational company with operations in the EU - thus Euro revenue and Euro sales? How can we protect margin on p&l ? I thought P&L hedging is not qualified for hedge accounting ? Can you please elaborate how this is done?

This question was asked during the Proformative webinar "Key Elements of a Successful Hedge Program."  A video of the webinar can be viewed here: https://www.proformative.com/resources/webinar-video-key-elements-successful-hedge-program

Answers

Topic Expert
Philippe Gelis
Title: CEO
Company: Kantox
LinkedIn Profile
(CEO, Kantox) |

Hi Kurt,

The best way to hedge is definitely "natural hedge". Meaning, you match your revenues and costs in Euros. The unmatched position has to be hedge with a traditionnal hedging product (forward, option...) or a corporate-to-corporate solution which make it possible to create a natural hedge with a third party.

Regards

Topic Expert
Helen Kane
Title: President
Company: Hedge Trackers, LLC
(President, Hedge Trackers, LLC) |

The election of functional currency is pivotal to responding to this question. If you are local currency functional, your margin hedging must be done via proxy. Generally intercompany transactions will serve as the proxy. It becomes a 2-part process. Step 1 – identify the amount you want to hedge. Step 2 – identify hedge-able exposures to determining how much you can hedge. In this case you would identify the 3rd party EUR denominated revenues and 3rd party EUR denominated costs. That is your exposure to EUR. Now identify “long EUR/short USD” qualifying exposures. This could be EUR denominated sales from parent to EUR sub, or USD denominated sales from parent to EUR sub, or USD denominated costs of EUR sub to 3rd parties. Then these proxy exposures can be hedged to protect the company margin using special hedge accounting applications under ASC815. If a company has transferred IP to a EUR headquarters unit that is designated as EUR functional, it can be extremely difficult to identify qualifying exposures. The management fees and other small intercompany transactions are rarely large enough to adequately hedge the exposure. This highlights the critical nature of the functional currency decision in key subsidiaries. I would be happy to elaborate further on any details.

Please note, if you hedge net through the interco, you protect net income not necessarily margin percent as the effective portion will skew the top line (or costs if net short). Margin % is protected when, for example, USD interco inventory is hedged by the sub into EURO. Then EUR rev and EUR CoGS will be protected to a margin % (but not a dollar value). One additional caveat is when hedging at the USD level, there may be a timing mismatch if the hedged item stays in inventory or deferred revenue at the foreign functional subsidiary.

Jono Tunney
Title: Director
Company: Atlas Risk Advisory LTD
(Director, Atlas Risk Advisory LTD) |

I'd add to this string that the success or failure of your P&L hedging program will rely on effectively measuring the underlying business impact of FX movements to the P&L. To simply book a FX hedging gain (loss) with no offsetting number against which management can measure the effectiveness of your hedging activity is setting your program up for failure. (e.g. you need a metric such as 'planning v. accounting rate' impact)

This is different from a balance sheet hedging program where remeasurement impact is a easy and obvious line item to compare effectiveness against.

Lastly - and this piece nearly everyone misses. The accuracy of you sales forecast will be DIRECTLY impacted by the magnitude and direction of the FX movement. For example, a stronger Local Currency may result in a lower volume of local currency sales as competitive forces drive down local currency prices. Thus your exposures tend to be *non-linear*. Spend lots of time with your sales force (and factories for that matter) understanding your competitive dynamics. Lots of ways to best match your true exposure with your hedging activity

2649 views

Get Free Membership

By signing up, you will receive emails from Proformative regarding Proformative programs, events, community news and activity. You can withdraw your consent at any time. Contact Us.

Business Exchange

Browse the Business Exchange to find information, resources and peer reviews to help you select the right solution for your business.

Learn more

Contribute to Community

If you’re interested in learning more about contributing to your Proformative community, we have many ways for you to get involved. Please email content@proformative.com to learn more about becoming a speaker or contributing to the blogs/Q&A Forum.