Why It’s Time To Stop Making FX The Corporate Earnings Scapegoat

Consider it the new normal. Consider it a rollercoaster ride. Consider it a reason to drink, down antacids or aspirin, or crawl under the covers and imagine white sandy beaches with easy ocean waves.

Whatever the case, the global economy is in a state of volatility, and signs indicate it won’t end anytime soon. That means retailers and other companies need to up their risk management and hedging games — and do so before one crisis or another (a currency collapse in Turkey one week, who knows what next?) puts corporate treasurers and CEOs into a panic, threatening companies’ profits, jobs, growth and survival.

In an interview with PYMNTS’ Karen Webster, COO Mark Frey of Cambridge Global Payments talked about the current state of risk management among businesses that operate in the commerce and payments world, and what’s coming next.

To be fair, Frey’s tone did not indicate that the sky is falling as the above paragraphs, but his point was as serious: Prepare well for this new world of volatility, where politics, tariffs, trade wars, rising interest rates and other factors are creating constant chaos, and where the relative stability of yesterday already seems like a distant memory.

Positive Disguises

The second quarter earnings season brought some positive surprises for investors, with companies such as Procter & Gamble, Mastercard, Visa and Walmart beating analyst expectations on revenue and earnings. However, positive growth can disguise looming threats. Volatility promises to increase and, soon enough, that will be “felt on income statements” and impact earnings, Frey told Webster. “These long-term trends can derail a business irrespective [of] how they are performing in the local currency.”

Granted, many companies already do a rough form of hedging by locating, say, manufacturing and other cost centers in certain countries, “but it’s not really efficient,” he said. “You are creating a whole infrastructure, rather than creating a financial hedge.”

Besides that, too many corporate executives use currency swings and their ill effects as an excuse, on par with bad weather or acts of God. “Some CEOs just throw their hands up in the air and say ‘there is nothing we can do about it,’” Frey added, “but there is.”

The general remedy? A long-term and proactive look from the point of view of the financial hedging and risk management opportunities. “Having a policy in place, and identifying risk that is material to the firm, takes some of that guesswork out of the equations,” said Frey. “It gives you insulation from exposure.”

Turkish Crash

Take the example of Turkey. Its lira has all but crashed and burned recently, amid a political rift involving the United States and its NATO ally. What’s good for U.S. tourists there is bad for exporters to that country, “even if that’s just 10 percent of your business,” Frey said. “All of a sudden, you had a material devaluation. These types of things can happen whenever you are working outside of your domestic jurisdiction.”

Turkey is only one crisis: “We will see more situations like what has transpired in Turkey and Venezuela,” he said.

A crisis always results in “911” emergency calls to firms like Cambridge Global. In fact, such a crisis is what usually leads to a company finally adopting a solid risk management and hedging plan. It also usually inspires top corporate executives to get beyond philosophical talk about crafting such a plan, to come up with solid numbers and a strategy that involves metrics, he said.

The benefits are real. He cited a Bank of Canada study, showing that corporates with such plans tend to have stronger returns on assets, less need for cash on hand and more ability to finance growth at lower costs.

Quantify Risk

Risk management goes beyond currency hedging. It involves figuring out, for instance, how exchange rates could ruin financial forecasts, and where an organization’s weak spots are by market, product category or other areas. “If you quantify the risk, then you can begin to determine where they are material enough for your firm,” he said.

Protecting against volatility might involve putting price adjustments into sales contracts, he said, but that just shifts risk to clients and adds another level of difficulty to the sales process. Smaller firms are much less likely to have the heft to do that than larger firms. Frey said, “In many cases, there are easier, simpler, customer-friendly ways to manage that risk yourself.”

In addition, he added, it always helps to look at industries that are very well practiced at hedging and risk management for lessons. Agriculture stands as one of those prime examples.

If and when the sky really does fall, those who have foreseen that crisis and made ample preparations will do much better than those who winged it. To put it another way: “It’s better to make a decision from a position of strength than weakness,” Frey said. “Too many firms don’t heed that advice.”