Volvo Cars' heritage from a volatile currency

How does a large multinational corporate handle the FX risk from being based in a country with a floating currency, such as Sweden? For answers, Nordea On Your Mind author Johan Trocmé interviews Volvo Cars Group Treasurer Daniel Aspenberg and Marcus Alfredson from Volvo Cars Treasury about FX exposures, how they are changing and how they are managed. The aim is to reduce the FX volatility in earnings and to keep total exposure within a tolerable limit. This approach would likely be kept if Sweden were to adopt the euro, and the potential benefits would include lower transaction costs and FX risks.

Johan Trocmé: Could you briefly describe how you approach FX risk at Volvo Cars? What are the key risks and currencies? Transaction risks versus translation risks versus balance sheet risks? How do you assess and manage them? 

Daniel Aspenberg: FX is, and has historically always been, a major exposure for Volvo Cars, even if it has become a bit easier to manage as our global manufacturing footprint has evolved and diversified into more locations than our plants in Sweden and Belgium. It remains a material risk for us, as we still have a limited number of production sites, but sales all around the world, in many different currencies. We accordingly see FX as a risk which we need to manage actively. A major focus is transaction risk in our daily flows, which also includes the EBIT translation risk in our foreign subsidiaries, but we also consider the translation of equity in the subsidiaries. 

Marcus Alfredson: Regarding transaction risks, we work with a forecast for the next four years. We put this into a model with correlations and volatilities, from which we estimate what we call cash flow at risk for the group. We report this to our CFO, who has been mandated by the board of directors to decide on hedging of FX and other risks, including raw materials and electricity. We review and discuss these with the CFO every quarter. The discussion usually culminates in being able to conclude that, with 95% confidence, we do not stand to lose more than a certain amount of money from FX movements. We want the discussion to conclude with how much risk we are able and willing to take. What we hedge is a share of the risk that we are exposed to. In addition, we have a continuous nominal hedge of the exposure from our four biggest currency exposures. Management hence always knows that we have hedged at least this minimum percentage of anticipated flows in year one and year two. And we can opt to hedge more, under the mandate from our board and CFO. We define hedging out to 24 months as structural, where we continuously add new hedges. Hedging 25-48 months is our strategic mandate, which we can use if we believe exchange rate levels are exceptionally attractive, or if we need to manage FX risks from a specific project or situation. 

DA: In our external financial reporting, we refer to an FX impact, which is the estimated y/y effect. With our hedging, we aim to reduce the volatility of this impact. Group management considers FX risks along with all the various risks the group is facing, and the mandate for us to hedge FX risks originates from a perceived need to reduce our risk in this area. Our hedging of translation risk in the earnings of our international subsidiaries is driven by an overall aim that as much of profits as possible are distributed to the parent company, obviously subject to our transfer pricing policies and any other restrictions. We think along similar lines regarding equity in our subsidiaries, where we make an active choice when we see a need to hedge the equity. We often do this with a net investment hedge, matching the currency of the equity with corresponding debt. All financial assets and liabilities in foreign currency on the balance sheet not related to subsidiary equity are kept FX-neutral. 

JT: From the company's point of view, what would be the optimal FX situation? A strong SEK, a weak SEK, a stable SEK exchange rate versus other major currencies? Or other FX factors?

MA: The key benefit for us would be stable exchange rates. We have major outflows in SEK, CNH and EUR. Theoretically, if these three were to strengthen against all other currencies simultaneously, that would be the worst outcome for Volvo Cars. But this would be purely the FX impact. There may be a macro hedge in it, as any currency appreciation driven by strength in these markets would also potentially benefit us in terms of demand. 

JT: Would you say that currency is a meaningful factor weighing into Volvo Cars’ investment decisions, such as technology centres or production sites, or choosing major suppliers?

DA: It is one of several factors in major investment decision. It is significant, but not right at the top. We need to consider available talent pools, supplier bases, the logistics of sourcing, political stability, trade tariffs and rule-of-law, to mention a few very important factors. But currency certainly plays a role, particularly from a group perspective, considering our global footprint and currency mix for costs and revenues. 

MA: There is this old article in Swedish business daily Dagens Industri from when the exchange rate was SEK 6-7 per USD, which someone showed me a few years ago. In the article, it was argued that we should consider exiting the US car market, as it would not be profitable to produce the cars in Sweden and export them there at such exchange rates. It feels like a different era from today. We now also manufacture in the US and have USD costs, for example from batteries. I think it is a good reminder that currencies move over time, that businesses need to evolve, and that there is a need to plan and act with a long-term perspective.