US dollar account in Luxembourg for excess yen provides solution to P&L volatility
Takeda Pharmaceuticals is like most financially healthy pharma companies in that it holds a large amount of cash on its balance sheet. Given Japanese Yen (JPY) is its functional currency, much of the company’s cash is in JPY.
The problem this company was trying to solve was twofold:
How to maximise its cash investment (interest) income without taking on currency devaluation risk (carry-trade risk) by investing in other currencies?
How to keep its cash fully liquid, even if the company did invest in other currencies.
The company decided that to enhance interest income it would like to invest the excess JPY cash in USD denominated investments. To do this, while meeting the requirements of solving both the short-term investing and liquidity problems, Takeda Pharmaceuticals proceeded as follows:
The company opened a segregated USD bank account in Luxembourg (owned by the Japanese functional parent); it converted excess JPY cash into USD and deposited in this investment account. This cash would then be invested in liquid USD investments.
“If we stopped here, we would enjoy the higher USD interest rates over JPY rates but also be subject to highly undesirable monthly P&L volatility as the invested USD cash would be re-calculated into JPY each month, potentially offsetting and even eliminating the interest income benefits,” explains Miho Kumazawa, Treasury Operations Lead.
To avoid undesirable P&L volatility, it planned to exploit Takeda’s significant external USD debt portfolio which was already designated as a net investment hedge accounting of Takeda’s USD investments in foreign entities (a net investment hedge accounting designation allows companies to post the P&L volatility arising from foreign (USD) debt into its equity cumulative translation adjustment (CTA) account, thus bypassing P&L). Most companies use net investment hedge as a static tool where a gross amount of foreign debt, at the time of debt issuance, is given this designation for the life of the debt.
“As a twist to the commonly used net investment hedge strategy, we wanted to include our foreign (USD) cash in our hedge designation, thus hedging the net foreign debt position rather than gross. However, here we faced the final problem that our cash balance in investment portfolio could change frequently and hence our net debt amount would not be static,” says Kumazawa.
As a final step, the company created a daily process where at the end of each day it re-adjusts the amount of foreign (USD) debt that is designated as the net investment hedge. This amount is equal to Takeda’s USD debt net of USD cash in its investment account on that day.
Best practice and innovation
The most unique aspect of the project is its simplicity and universal applicability. Any company with foreign currency debt and a desire to invest its cash in that currency can easily employ this strategy.
By making the net investment hedge accounting designation dynamic, Takeda was able to achieve the following benefits:
Earn USD interest rates (~2%) rather than JPY rates that are close to zero.
Completely eliminate any P&L risk arising from holding USD cash in a JPY functional entity.
Its USD cash holding in Japan can be liquidated to pay USD debt, regardless of prevailing USD/JPY trading levels.
Liquidity problem was solved by investing the JPY cash in highly liquid US treasuries.
For every US$1bn subjected to this strategy in 2019, the company enjoyed an incremental 2% yield enhancement (US$20m in cash interest income for every US$1bn invested) at zero additional risk.