China Foreign Exchange | Haier: Exchange Rate Risk Control in Company Mergers and Acquisitions

Haier, as one of the earliest transnational corporations from China, whose business goes in more than 30 countries/regions, is facing exchange rate risk of more than 19 currency pairs. In 2013, Haier’s financial sub-company was licensed to operate financial derivatives and started this business. After years of practice in and out of China, Haier gets rich experience in developing, managing, and selling Financial risk management products.

On January 15, 2016, it was announced that Haier would purchase GE’s household electrical appliances department at a price of 5.4B USD, and this transaction would be completed with Haier’s own fund and annexation loan. Haier’s own fund would be 2.2B USD, accounting for 40% of this transaction. Since this transaction will be finished with USD, while a significate part of Haier’s own fund is from RMB fund, thus to manage the risk of exchange rate effectively, and to keep the total amount of RMB fund within the given range of the budget, are problems Haier must solve.

Early in 2016, in order to better coordinate resources to cope with exchange rate risk, Haier Functional Holdings integrated Haier’s exchange teams, imported talents on transnational bank, hedge fund and IT and registered Hai Cloud Exchange in Hong Kong to provide foreign exchange trading services and financial risk control to member company of Haier group and other industrial clients. And to manage the rate risk in purchasing GE’s household electrical appliances department becomes a “test” of Hai Cloud Exchange’s expertise after its incorporation.

 

Study market deeply and provides hedging scheme

From 2014, RMB started to depreciate. In 2015, Offshore RMB to USD fell to 6.57 from 6.22, a 5.68% decline. At the same time, the exchange rate began to fluctuate in two directions, and the fluctuations in a single day is rising gradually. These changes significantly increased the risk in exchange market and the uncertainty of this purchase.

According to Hai Cloud Exchange’s simulation, if the rate of USD to RMB fluctuates 5%, a payment of 100M USD will result a loss or gain of 30M RMB in exchange. With such a huge exchange risk, Haier must manage exchange rate risk actively from a strategic angle of risk management. Considering US started to exit QE step by step from early 2016 and the market has a big expectation of the USD appreciation, Haier has 3 options:

Option 1, Do not do risk management, and purchase USD at spot price on the day of delivery

After the exchange reform in August 2015, the fluctuation is much bigger and the risk is also rising. USD steps to interest rate hike cycle. Once the operation is done in the wrong direction and without any risk management, exchange rate risk may eat all the industrial profit. It is a big risk.

Option 2: Lock the exchange rate risk in a long term

In early 2016, offshore RMB appeared a fast depreciation to USD, which increased the market panic. The cost to manage the risk of offshore RMB to USD increased a lot compared with that in 2015. Overseas markets have over-anticipated the range of depreciation of RMB: 3-month long term cost increased to 1.2%, in other words, we can get profits from long term locking rate risk only if RMB depreciates to 6.58 or more from 6.50 in 3 months. But the cost of more than 100M RMB is too high for the company.

Option 3: Lock rate risk with combined option

Faced with complicated market environment, Hai Cloud Exchange’s team believes that, to design first-class hedging trade solutions, the first job is to make rational market judgment based on customer needs. From the direction of the whole financial market reform, after joining the SDR, RMB will act more in supplementing and gradually replacing existing international reserve currency in emerging markets and neighboring countries. The object of RMB exchange rate policy should be to keep the relative stability of the exchange rate to the currencies in the emerging market and to keep the flexibility of the exchange rate to USD within a suitable range so that RMB’s rates will not be in a rhythm as a “para-USD”, and the independent influence of RMB in the international currencies can be enhanced.

In late January 2016, the spot exchange rate of offshore RMB to USD fell slightly following daily central parity. The amplitude was much narrower than the New Year’s Day. With an overview of the exchange rate of RMB in January, it was generally keeping stable. From the domestic perspective, PBOC declared its determination of keeping RMB’s exchange rate stable, and the prophase measures to suppress the expected depreciation of the RMB have been effective; The promotes of internationalization of RMB also moves forward steadily. From the international perspective, the momentum of the global economic recovery is not clear, and countries are competing for ease; the probability of US to increasing interest is reducing. Under the common effect of these domestic and foreign factors, the pressure of RMB depression is reducing, and RMB will be stable in short term. Based on the above analysis, Hai Cloud Exchange’s team believes, in the first half of 2016, although RMB to USD will continue to fall, the amplitude will be smaller. We expect that the rate will be in 6.4 to 6.8 with a high possibility.

After the above analysis, Hai Cloud Exchange’s team chose option combination to lock the exchange in purchasing GE’s home appliance: 6.6-6.8 Call Spread. There were two merits. First, the cost was very cheap. The call option with a strike price of 6.6 was lower than the call option with a strike price of 6.4. Therefore, we chose 6.6-6.8 Call Spread. Second, interval hedging was ensured. If the option expired in June, and RMB appreciated unexpectedly, then the customer could give up the exercise and purchase the exchange at the favorable spot rate at the time. In other words, Call Spread could effectively lock the rate risk of the 6.6-6.8 RMB against USD. Meanwhile, if the RMB appreciated, the customer could purchase exchange with a lower spot rate. The risk of this option combination was that if the RMB exchange rate fell to 6.8 or more, it would exceed the rate risk range of 6.6-6.8. For this, Hai Cloud Exchange’s team thought it would hardly happen. So they recommended 6.6-6.8 Call Spread to the customer. After getting the customer’s recognition, Hai Cloud Exchange’s team completed the option trade during February-April according to the scheme.

Summing up the experience of safe operation

The foreign currencies market in the first half of 2016 was just as Hai Cloud Exchange’s team had expected: the offshore RMB first appreciated and then deprecated. In end of May, when option expired, RMB to USD had deprecated to about 6.55, then the counterparty of this trade gave up the exercise. Haier locked the cost of the acquisition by purchasing spot USD. This plan finally avoided the exchange rate risk effectively. Compared with long-term lock plan, this plan saved 0.45% of the financial cost for the customer, and in general saved more than 100M RMB for Haier.

On June 6, 2016, Qingdao Haier released an announcement that in the trade of Haier purchasing GE’s household electrical appliances department, a formal delivery of assets had been made, with a total payment of 5.58B USD. All the RMB payment was ready to be completed in the budget and had already been exchanged to USD and payed to GE. On June 7, GE Appliances was renamed as “GE Appliances a Haier Company”.

In summarizing the hedging operation in the case of Haier purchasing GE Appliances, we can conclude that:

1. When making the object of exchange risk management, it is better to take into consideration the method of other enterprises in the same industry and one’s own characteristics. In this case, thanks to the reserve of talents with years’ exchange rate risk management experience, and the flexible risk management policies and mechanisms, Haier can manage risk by choosing complex option portfolio products.

2. In choosing exchange risk management method, it’s better to be conservative, radical and dynamic. In this case, for exchange rate risk management, Haier chose option portfolio tool, instead of choosing radical forward or conservatively doing nothing. That was the result of the rational assessment on exchange rate risk, gain/lost, and prudent and comprehensive consideration.

3. The object of exchange risk management should be based on taking full consideration of cost and accounting, and on reducing the uncertainty of economic cost. Buying option is a cost in accounting, but Haier didn’t ignore the importance of economic cost because of the increase in accounting fee. Taking the control of final economic cost as our priority, is one important reason why this option product can be used smoothly.

4. Build a scientific risk management strategy system; On the basis of industrial demand, choose the right and appropriate financial tools (Image 2). For example, in the RMB appreciation stage, enterprises are certain about their export order. Therefore, USD-RMB spot rate can be locked with long-term exchange settlement and a certain amount of interest compensation can also be obtained by swap point. In the RMB depreciation stage, overseas engineering enterprises cannot be sure whether they can win the bid. In this situation, with the potential demand for foreign exchange, it is better to lock exchange rate risk with lower cost by by buying an extra USD call option.

The purchase of GE Appliances by Haier, is not only a milestone of Haier’s internationalization, but also a big event for Chinese household electrical appliance industry in going international. We believe that the exchange risk management of Haier in this purchasing process, can provide reference for domestic enterprises in going international, and also provides effective and complying ideas and choices for exchange risk management in the “Belt and Road” project, including the relevant business, infrastructure construction, international trade, outbound investment etc.