“A ‘Gordian knot’ solution of simply writing off all loans would have also eliminated the FX noise in earnings, but would have materially impacted the statutory results and capitalisation of many legal entities in different jurisdictions,” says Fred Schacknies, VP & Assistant Treasurer at Hilton Worldwide.
Hilton therefore needed a solution that would provide visibility across the portfolio and one that had the ability to mitigate both cash flow risk and earnings risk, without the adverse ancillary consequences for the legal entities involved.
At first, the company needed to gain control and visibility over the transaction data by capturing all intercompany loans in a single system. With a single, comprehensive data-set in hand, it could then assess the earnings and cash flow characteristics of each loan in the portfolio, with input from individuals in the treasury, tax, accounting and operations finance teams.
As a result, risk could be measured in terms of notional exposure, simple factor sensitivity and probabilistic models (value-at-risk), which could then be calibrated with the benefit of historical results data. With this information:
Any new and existing loans with cross-currency cash flow impact were targeted for hedging under the umbrella of a new in-house bank structure.
Any loans deemed to be of a long-term nature were designated as such per ASC 830 (US GAAP).
Remaining loans were flagged for restructuring under a rationalisation plan.
Best practice and innovation
Most multinationals engage in intercompany lending and many struggle with the cross-currency implications, which can be clouded by byzantine considerations of accounting, statutory reporting, tax planning and financial markets.
Hilton’s approach demonstrates best practice and innovation by:
Incorporating diverse inputs from a multi-functional team.
Clearly defining and differentiating its objectives with respect to FX risk to both earnings and cash flow.
Incorporating robust data management and advanced risk measurement techniques. These views of risk allowed Hilton to measure potential impacts to earnings and to cash flow, at various levels of aggregation, from individual transactions to legal entities, countries, regions and the consolidated corporate parent.
Moreover, by segregating the investor optics of GAAP earnings from the underlying economics of cash flow risk, Hilton was able to achieve meaningful improvements on both fronts. By routing all cash-impacting intercompany activity through an FX hedging programme, Hilton has been able to reduce FX cash flow risk to a negligible level.
Schacknies concludes: “Our intercompany loan portfolio has been reorganised and dramatically simplified. All data is in one place and subject to a common policy. We have clear visibility to the FX impacts to both earnings and to cash flow and the ability to measure potential future risk to each.”
For other organisations undertaking similar projects, key principles to consider are:
Start with clean and comprehensive data.
Ensure centralised controls over transactions.
Consider independent impacts to cash flow and earnings and appropriate solutions for each.