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Can Treasurers Hedge Offshore Cash?

By N.Essaides - AFP. Association for Financial Professionals. (Published: 2012-08-20).

Can Treasurers Hedge Offshore Cash?
The turmoil in Europe is delivering a double blow to the profits of U.S. multinationals: lower sales in weaker economies combined with lower U.S. dollar-equivalent revenues as the weaker dollar translates into fewer dollars at home.

It’s easy to find evidence of the pain, as AFP highlights in an upcoming report on FX risk management next month. But reduced revenues are only part of the FX-triggered conundrum. The other part is that the value of trapped offshore cash also is declining. “This is a growing problem for U.S.-based companies,” said Helen Kane, president of Hedge Trackers, an FX accounting software and consulting firm. Against the backdrop of a depreciating euro, “folks are concerned about their retained earnings,” added Ramon Bauza, Managing Director and Head of FX Risk Advisory with Deutsche Bank.

The taxes. Here’s the problem: Companies are sitting on loads of cash, mostly in Europe, and because of U.S. tax policy they are unable or unwilling to bring it back home at the required to a 35-percent tax rate. Fed data showed Q1 2012 cash balances at nearly $2 trillion. That’s double what it was 10 years ago. And it keeps growing: According to the 2012 AFP Liquidity Survey, about 41 percent of organizations increased their cash balances in Q1. In May, CFO Journal quoted a JPMorgan study which concluded that half or more of that cash is trapped offshore. So treasurers are waiting for the sequel to the Homeland Investment Act (HIA), a 2004 tax holiday that gave companies a one-time pass to repatriate offshore cash at a reduced tax rate. “When, or whether, HIA 2 comes to be is a hot political question,” said a risk advisory director at a major U.S. bank. In the meantime, that cash is exposed to the weakening euro.

The accounting. This is where accounting enters into the equation. The simplest risk management solution is to hold the cash in U.S. dollars. But many U.S. companies have euro-functional subsidiaries (subs), and most centralize their liquidity in one sub. When that happens, there is a dollar asset on a euro-denominated balance sheet, creating monthly re-measurement risk, which hits the P&L head on. That risk can be hedged with forwards to eliminate the accounting noise, but that tactic synthetically converts the dollars into euros, which basically gets back to square one: a euro balance losing its dollar value. So it makes no economic sense.

Other companies just keep their cash in euros. There’s not a visible hit to P&L but there’s also no protection against a declining euro. So how can companies protect the value of that cash?

The solutions. Experts like Kane, Bauza and Ivan Asensio, Head of FX Risk Advisory & Sales Structuring, HSBC Americas report that more companies are looking at another avenue of protection: using a net investment hedge (NIH), which are a category defined in FAS 133. They’re designed to protect the value of a foreign sub’s equity, but almost no one uses them for that reason. After all, why do a cash transaction to protect a shift in equity value if there’s no intention of liquidating the sub? But in this case, the favorable accounting for NIHs can be used to create an economic layer of protection for retained earnings. An article in the upcoming October issue of Exchange will detail the different structures and their pros and cons.

For now, corporate treasurers need to remember this:
- All of the NIH structures assume an eventual repatriation of the trapped cash. If you don’t believe that the money is at some point coming home, the solutions don’t make sense.
- There are no “free lunches,” so hedging offshore cash will have an embedded or outright cost. That cost arguably is far outweighed by the benefit of a predictable economic value of trapped cash.
- Finally, it’s going to be hard to get senior management on board. Treasury will need to work hard to present the solutions in clear terms highlighting the economic benefits.

To learn more, be sure to download AFP’s forthcoming CTC Hedging Guide and sign up for AFP’s upcoming webinar on hedging on September 20.

Mercredi 5 Septembre 2012