Law Times

PAGE 12 FOCUS Minimizing currency risk Foreign-exchange fluctuations a key challenge C BY JULIUS MELNITZER For Law Times anada and the United States are each other's largest trading partners. As such, importers and export- ers in both countries face com- mon risks involved in currency fl uctuations. As the last few years have demonstrated, the currencies' relative value at any particular time is largely unpre- dictable. At the same time, the trend to globalization continues un- abated as markets become in- creasingly dependent on each other. As well, the uncertain economic times have shown that credit risk components are also in play. American International Group Inc. was a "very popular counterparty in the foreign- exchange market," says Paul Belanger of Blake Cassels & Graydon LLP. "If the U.S. government hadn't stood be- hind the company, that market would have been a real mess." Aggravating the situation is the emerging threat of sover- eign risk to the stability of in- terdependent foreign-exchange markets. Consider, for example, the situations governments in Dubai and Greece have found themselves in. "Th e most cred- itworthy members of the pri- vate sector in any country can't have a credit rating that's better than that of the government," Belanger explains. "So, for ex- ample, if someone is looking for a letter of credit from a Greek bank, they may want to deal with an international bank operating there." Businesses on both sides of the border vary widely in their approaches to foreign-exchange risk. "Th ere's a temptation for the less sophisticated to throw up their hands a bit," Belanger says. But doing nothing can be more dangerous than ever, particularly since there are a number of techniques avail- able to manage the risk. Which approach is appropri- ate depends on a number of considerations. Th ese include the percent- age of receivables or payables that must be settled in foreign currency; the sensitivity of a company's profi tability to for- eign-exchange fl uctuations; the ability to match the due dates of receivables and payables in a particular currency; the reli- ability of export and import dates; whether it's possible to pass on currency losses to customers; the need for stable cash fl ow; and the willingness of customers to share foreign- exchange profi ts and losses. "Th ere are companies that spend a signifi cant amount of time analyzing their revenue base and trying to align expens- es so that they can eliminate the foreign-exchange exposure," says Edwin Maynard, head of Paul Weiss Rifkind Wharton & Garrison LLP's Canada prac- tice. "Some companies with a great deal of U.S. revenue may well decide to raise capital in U.S.-dollar denominated debt so that they can use their U.S. revenue to pay off interest and principal costs." Some multinational compa- nies will go so far as to mini- mize risk by shifting operations to production sites in either the United States or Canada as currency values fl uctuate. Ultimately, however, the more a company relies on foreign-exchange cash fl ow, the more likely it is that it will resort to hedging. Companies can hedge selectively, protect- ing only some of their foreign transactions, or they can hedge systematically by engaging in the practice whenever foreign currency is involved. Th ere are, of course, various ways to hedge. Forward contracts and swaps are fl exible and liquid in the sense that the amount and dates can be matched with particular commercial transac- tions. Forward contracts are agreements to convert one cur- rency into another. Th e disad- vantage of forward contracts, of course, is that the hedger won't profi t from favourable swings in foreign-exchange rates. Swaps involve simultaneous spot and period transactions of one currency against another and are useful for companies with receivables and payables in the same currency where the due dates don't match. Call and put options give Ontario Lawyer's Phone Book 2011 Your most complete directory of Ontario lawyers, law firms, judges and courts With more than 1,400 pages of essential legal references, Ontario Lawyer's Phone Book is your best connection to legal services in Ontario. Subscribers can depend on the credibility, accuracy and currency of this directory year after year. 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Such options protect holders when the exchange rates become less favourable. Holders can also profi t when exchange rates shift in their favour. Other possibilities include collars, which combine two contracts to create a specifi c profi t diagram. Collars involve the simultaneous buying and selling of put and call options. A zero collar option ensures that the price of the option turns out to be zero. Hedging, however, requires counterparties, which means taking the risk that the coun- terparty will perform. Th ese risks have grown as the foreign- exchange market has enlarged and become more diverse. While commercial banks dom- inated the market originally, investment banks, foreign- exchange dealers, brokerages, multinationals, money manag- ers, commodity traders, insur- ance companies, governments, central banks, pension and hedge funds, and investment companies are now among the participants. Otherwise, the market's growth and complexities have required a continual evolution in trading and operational procedures, trade capture sys- tems, and risk-management tools to ensure the integrity of the system. One way to mitigate the risk is through widely recognized standardized documentation. Two such sets of documents are the International Swaps and Derivatives Association's (ISDA) master agreements and the International Foreign Ex- change and Currency Option (IFXCO) master agreements. "Th e ISDA documentation For a 30-day, no-risk evaluation call: 1.800.565.6967 Canada Law Book, A Thomson Reuters business. Prices subject to change without notice, to applicable taxes and shipping & handling. www.lawtimesnews.com OLPB_2011 LT-1/2pg 4X.indd 1 11/9/10 3:41:59 PM HA1210 provides certain protections, such as the ability to set off countervailing agreements, to net and to collateralize obli- gations," says Richard Coll of DLA Piper in Washington. 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