Hazards in the currency game: Disclosure by Shell of a dollars 200m loss highlights the perils of dealing. Russell Hotten reports

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The Independent Online
AS ROYAL Dutch Shell shocked its shareholders last week with the revelation that it had lost up to dollars 200m (pounds 140m) on foreign exchange dealing, the spotlight once again fell on the way companies speculate in the currency markets.

Few investors were holding Shell's board directly responsible for the lapse, but it stirred uncomfortable memories. Not since the Allied-Lyons debacle two years ago has so much attention been focused on the growth in companies' corporate treasury functions and the exposure of some multinationals to currency fluctuations.

'There's no doubt that Allied's foreign exchange losses injected a note of caution throughout UK boardrooms,' said one currency analyst. 'But because of the sophisticated nature of international finance, things like this will happen. You could say it's an accident waiting to happen.

'Nevertheless, a little bit more control over treasury staff could have saved both Allied and Shell a lot of money and a lot of red faces.'

Shell's losses were caused by dollar-yen speculation at Showa Shell Kekiyu, the Japanese quoted company in which it has a 50 per cent stake. As well as losing pounds 131m in 1992, Shell will lose an estimated pounds 65m in the first quarter of 1993. Total foreign exchange futures losses at Showa could total dollars 1bn.

Showa is believed to have secretly built up a currency exposure of dollars 6.4bn in the past four years. It shows there were no controls, and also the ease with which liabilities can be concealed.

Showa pays for crude oil in US dollars. In 1989 the company bought dollars forward at an average of 145 yen each, carrying through its position in the hope the currency would rise. They gambled wrongly, and the dollar fell to end 1992 at about Y125. It was a 'gross contravention of the company's internal procedures', said a statement. Retribution was swift. About pounds 166m was wiped off the stock market value of Shell Transport, and in Japan heads began to roll.

One investor said: 'I do not blame Shell, but the fact that Showa was able to build up such exposure without being noticed was worrying. Oil companies are particularly dependent on having sophisticated treasury operations to handle large volumes of transactions. It makes it difficult to spot unauthorised deals.'

Shell was criticised for having just one non-executive director on the Showa board to protect its investment. In London last Thursday, Sir Peter Holmes, chairman of Shell Transport, the oil giant's UK operation, announced that there would be a tightening of reporting procedures, and that Neil Gaskell, its head of investments, was being dispatched to Tokyo to sit on the Showa board.

Yet, as has been shown on countless occasions - at Lufthansa, Volkswagen, Allied-Lyons and a host of minor companies - it is easy to undermine the system no matter how sophisticated the monitoring procedure.

Kees Schloters, a currency expert and director of S G Warburg, believes many companies are hit because of their sheer ignorance of the risks. Basically, directors do not fully understand what is going on, and so give corporate treasurers a long leash.

He said the importance of corporate treasury departments grew with the increased volatility of financial markets and a more complex range of financial instruments, such as swaps and options.

Corporate treasury used to be about managing company debt and liquidity. But the growth in international trade meant companies had to hedge against currency fluctuations. Then corporate treasury itself became a separate profit-generator for the company.

At Allied-Lyons, which lost pounds 150m in 1991 speculating on the dollar, its aggressive treasury team was keen to improve the profit potential of currency dealing. It was not simply hedging currencies, it was speculating through currency options. Members of the dealing team, who cut their teeth in hectic City trading rooms, may have forgotten they had changed jobs.

The financial markets are constantly swept with rumours of companies being badly exposed to currency fluctuations. But Chris Jones, head of the corporate treasury consultancy group at Price Waterhouse, believes companies are generally more cautious.

'It is a question of whether you have a risk appetite or are risk averse,' he said. According to his study of 41 large UK companies, only 5 per cent said they were engaged in currency speculation. About 75 per cent saw corporate treasury as a simple cost-centre to hedge currencies, with the rest somewhere in the middle.

'The majority of companies are clearly risk-averse,' he said. 'There is a trend towards more active risk management and less aggressive risk-taking, a consequence of recent highly published losses by corporate treasurers.'

Even so, he agrees that it is difficult to stop a maverick trader undermining the system. 'It is common among traders who get into problems to go double or quits. It's like a roulette table: if you lose two chips on red, you put on four next time. Then eight, then 16.'

Several companies are well known as big players in the foreign exchange market. BP Finance is regarded as having one of the most sophisticated market trading operations within industry. SmithKline Beecham and Hanson are also seen as shrewd operators.

What marks them out is a tight reporting procedure and clear foreign exchange policy. Mr Schloters said: 'The best companies have developed more rigid guidelines and a specific foreign exchange policy. They have a clear idea of the risk, what instruments to use, and how active they will be in the market.'

The complexity, and secrecy, surrounding corporate treasury is worrying for investors. Currency commitments do not appear in the balance sheet and only the rudimentary facts are picked up in the audit. Foreign exchange can be a significant source of earnings or losses, yet exposure is easy to hide.

'It is difficult to get precise information about whether a company is losing money and what instruments are being used. Financial reporting is to some extent lacking if it excludes off-balance sheet items like the financial commitments in foreign exchange,' Mr Schloters added.

Nor would companies be keen to have such sensitive information made public. For example, take two German car makers exporting to the UK before the pound tumbled out of the ERM on Black Wednesday. Company A was fully covered on the fall of the pound while company B was not. Company A could therefore afford to give away a little bit of profitability to gain market share and undercut its competitor.

So what guidance is there for investors wanting detailed information on a company's foreign exchange dealings? 'None,' Mr Schloters said.

(Photograph and graphs omitted)