How multinationals are coping with the currency crisis.

By Catherine Lacoursiere

Multinational corporations that manage their cash flows from Southeast Asian operations have been waiting for regulatory barriers to fall for a long time. But the recent currency crisis and the deregulation that followed was far more than they bargained for.

Over the shorter term, it is somewhat of a Pyhrric victory. New government restrictions and illiquid markets have make it even more difficult to manage cash in the region. But over the longer term, recent events point the way to more mature domestic capital markets and a more sophisticated risk management culture in Southeast Asia.

The proverbial finger removed from the dike was the devaluation of the Thai baht, which was quickly followed by further devaluations and high interest rates throughout the region as Southeast Asian nations defended their currencies.

This has created several obstacles for corporate risk managers in the region. The foremost is a breathtaking lack of liquidity. Long-term hedging has dried up for the most part, with no real interbank market 12 to 18 months out. As a result, corporates are structuring their hedging strategies around the more liquid, short end of the market, managing their positions six to 12 months out. Even then, there still is not a lot of activity; wide bid/offer spreads and low deal volumes prevail. Most corporates say they are focusing on the next three to six months, after which they hope rates will have come off and they will be able to lock-in at more attractive rates.

"The volatility makes it hard to stay ahead of the game. Premiums are too expensive, and some banks will not even give quotes.” Robert Yenko treasury manager, Asia, Intel

Most of the hedging action is taking place with plain vanilla instruments and in the short-term cash markets. The short-term spot and forward markets still have a reasonable degree of liquidity, and that has supported a limited market in short-term vanilla currency options and swaps. There are, however, a reasonable amount of foreign exchange barrier options out less than two years. Interest rate caps, floors and collars are virtually nonexistent, however.

Players are now taking bets on how long it will take for the markets to rebound and which countries will come around first. "Multinational corporations are waiting to see the dust settle,” notes Quentin Hills, head of derivatives marketing, Asia, for Citibank Financial Markets, who adds that interest rate volatility is still quite high and hedging is exorbitantly expensive in the region.

For now, hedging strategies can be a vicious circle. Even if a corporate wants to go into the market, it may have a difficult time finding a bank willing to do the deals. Besides illiquidity, banks are further constrained by the capital controls and restrictions imposed by many of the central banks in the region. Malaysia, for example, has curtailed short selling, and Thailand has responded to speculative interest with a two-tier capital market that quotes higher rates for offshore players. Central banks are also exerting pressure on both local and foreign banks to limit speculative activity, thus limiting dealers' ability to lay-off risks and further exacerbating the credit crunch. The general deterioration in counterparty credit, in turn, means that there are fewer counterparties with which banks are willing to deal.

Most of the largest multinational corporations, which often have prudent hedging policies in place, managed to escape the carnage. Multinationals or joint venture companies with American or European companies were also active and sophisticated hedgers. "Hedging is becoming more expensive from India to South Korea,” notes Robert Farrow, assistant treasurer at General Electric's Singapore-based regional treasury group, which turns over about $2 billion a year in foreign exchange transactions on behalf of its 11 operations in the region. At GE, all foreign currency borrowings are hedged full stop. Transaction exposures are hedged for the period of the documented exposure, from the date of the invoice to the scheduled payment of the invoice. For now, GE hedges out in the three- to six-month range. That leaves it ample leeway to respond to market changes.

But not all multinationals got off easy, according to John Ellis, senior vice president at Bank of America, Hong Kong. One market that caught some multinationals short was Indonesia, where the wide interest rate differential—9 percent to 10 percent—inspired many to take the currency risk with little expectation that the rupiah would depreciate.

Thailand presented its own set of problems. Many multinationals tended to be fully hedged in the lower-yielding Thailand market. Domestic Thai corporations, however, tended to hedge against an unofficial currency basket, made up of 80 percent U.S. dollars, 8 percent Deutsche marks and 12 percent yen. The basket is 4 percent to 5 percent cheaper on average to hedge than the Thai baht. But when the U.S. dollar pegs failed to hold, many domestic Thai corporations were caught short.

Intel has also has found the cost of hedging prohibitive. "The volatility makes it hard to stay ahead of the game. Premiums are too expensive, and some banks will not even give quotes,” says Robert Yenko, Intel's treasury manager for Asia. "If the banks do quote you, you may already be out of the money when you ask for the quote. That makes the whole thing moot because you have to readjust your strike price again.”

Intel has a unique and enviable natural hedge in the foreign exchange markets. The chip maker, which does about $5 billion annually in the region, benefits because its revenues are dollar-based. Its exposures, about $100 million in foreign exchange transactions a month, are on the liability side, mostly for currency spending for subsidiaries in the region. Intel covers its $100 million in monthly regional foreign exchange exposures with outright forwards.

"With the dollar link broken, we are seeing the beginnings of modern corporate treasury management in the region.” Azem Mistry head of derivative marketing HSBC Markets, Singapore

DuPont has taken active steps to assist its customers during the currency crisis. It has seen a dramatic rise in business flowing through its Singapore-based Dragon Finance Center, which provides support through its partner banks to its customers in the region. Webber Lee, regional treasury manager at DuPont, says he is seeing a boost in demands for financing assistance from customers in Thailand and Indonesia, where short-term interest rates are skyrocketing. Indian, Chinese and Filipino customers are also big borrowers. Given the current financial market turmoil, DuPont's customer financing assistance program may be a critical lifeline to many of its customers. "Our objective is not to make profits on the spread,” explains DuPont's Lee, "but to assist our business growth through better offerings to customers.”

At this stage, the crisis has dried up interest in more sophisticated strategies. Azem Mistry, head of derivative marketing at HSBC Markets in Singapore, says that until recently he was seeing some interest in exotics in Thailand and was starting to see the same in Indonesia. Most were cost-reduction structures involving customers assuming a limited degree of risk to reduce the cost of hedging. In particular, corporates seemed interested in selling U.S. dollar interest rate floors and digital floors. On the currency side, digital options were being used more by corporates and other players to put on range trades. The Thai baht against the dollar was a popular play.

According to other market sources, nondeliverable forwards were also becoming more commonplace against the Korean won, the new Taiwan dollar, the Philippine peso and other currencies with which convertibility was an issue. GE, for example, was using Korean won nondeliverables. Although it was doing most of its hedging with plain vanilla instruments, it was also starting to use barrier options and other premium-reduction techniques. But when the liquidity in the currency market dropped off, so did corporate interest in things exotic.

Despite the short-term pain, most perceive the shaking up of the Southeast Asian Tigers as a positive development on the road to more mature and tradable markets emerging at the end of the day. "With the dollar link broken, we are seeing in the region a change in corporate treasury management to an active, hands-on exposure-management style,” notes HSBC's Mistry. Bankers now expect medium and smaller companies to become more active in the marketplace. And Mistry says he is seeing a lot more activity in Indonesia from local companies that were jolted into a risk management mindset after witnessing the increased volatility in the currency and interest rate markets in the region.