Foreign exchange—or forex—hedging is used by technology companies like Apple and Samsung as insurance against currency fluctuations, but new Dodd-Frank rules governing the practice place an added burden on technology firms.
Globalization has led to the import and export of many goods and services. Consumer demand for reasonably priced goods led the electronics industry to outsource its labor and production to countries where it is cheaper to buy and assemble the components needed to make the product. For example, a Japanese firm may order parts from another country, ship the parts to China or Vietnam for assembly, re-import the items to check quality and export the whole product to another destination for packaging and delivery, according to Spiderman Bouncer Slide Combo.
The process may take several months, though currency markets will likely experience some fluctuation, resulting in varied costs of between five and 10 percent for each step of the process. Technology companies, however, must manage changes in the currency markets in order to maintain a fixed price for finished goods. While a company could negotiate its buying and selling contracts in its home country’s currency, the scenario is unlikely, leading many large corporations to participate in forex hedging as insurance against currency fluctuations.
Treasury analysts at large companies examine the production process and determine their exposures on a cumulative basis before deciding on a forex hedging strategy. Financial derivatives are also used to much of the same purpose—firms pay a premium to mitigate against risk but come out on top if the markets stay their course, Market Daily News reports.
Before the financial crisis, AIG used financial derivatives to hedge against losses in the mortgage-backed securities market, though the company ultimately ended up losing $18 billion on credit default swaps. Over the past decade, other companies lost nearly $40 billion in similar derivatives-related events, leading regulators to enact the Dodd-Frank Act, which is designed to limit risk and speculation in the derivatives industry.
Technology firms must now prepare to face a number of examinations and questioning from regulators regarding the acceptability of each forex hedging transaction, the accounting rules of which are already complex and contain a number of gray areas. Though treasury analysts are accustomed to recording and reporting their actions, the additional requirements under Dodd-Frank could impose a costly burden on technology firms, according to Market Daily News.