Exchange rate volatility: who bears the risk?

Volatility in foreign exchange rates seems to be a current feature of economic life. And it’s surely economically significant for the vast majority of multinational groups.

Which raises the question from a TP perspective: which entity or entities in the group are intended to bear this risk? And is that position borne out by the intercompany agreements which are actually in place?

The starting point is to define what we mean when we talk about FX risk or currency risk. And then map the underlying issues against the relevant provisions of the agreements, in line with the approach illustrated in the diagram above. The ultimate aim is to ensure that after-the-event statements in TP documentation are substantiated and verifiable by reference to the applicable agreements.

FX risk may be a subset of market risk, in terms of the prices which customers are willing to pay.

FX risk may also be a subset of supply risk, in terms of the cost of procuring goods or labour etc.

It may be a subset of treasury risks, in terms of managing the impact of timing differences and movements in exchange rates.

Sometimes the TP intentions are easy to understand, such as where there is a ‘central entrepreneur’ which is intended to bear all material risks. But sometimes the situation is more complex, such as where there are multiple entrepreneurs.

As is so often the case, the first step towards finding the right answer is making sure that you're asking the right question.

Article by Paul Sutton

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