Foreign Exchange Risk in M&A Transactions
Cross-border M&A transactions are rife with foreign-exchange risk. For example, in an acquisition, one of the parties might be valued in its home currency whereas the transactions itself might involve a different currency (e.g. a German company might purchase a Chinese company and pay in Euros). M&A transactions are lengthy, with respect to the negotiations and the approval process, which can lead to significant exchange rate risks.
Such risks can be hedged. One common way to hedge such risks is by locking in the exchange rate with the bank. Doing so removes both the risks and the benefits of fluctuations in exchange rates. Another way to hedge the risks is through foreign exchange options with the bank. This allows the holder of the option to realize benefits from exchange rate changes while protecting the holder from the risks.2
The Impact of the RMB’s Inclusion in the SDR
Inclusion of the RMB in the SDR will have both short- and long-term effects. In the short-term inclusion of the RMB in the SDR is primarily a symbolic gesture, it represents that, in the view of the IMF, the RMB is a freely usable currency. In the long-term, there is a strong expectation that the policies surrounding currency exchange in China will continue to liberalize. One would, therefore, expect further gradual removals of limits on convertibility and policies that gradually allow the exchange rate to be driven by market forces.
As convertibility is increased, cross-border M&A transactions, as well as the subsequent business, between Chinese and foreign parties are likely to become easier and, as such, more attractive. On the other hand, foreign exchange risks, such as discussed above, will also grow. Hedging, via the techniques discussed above or otherwise, is therefore likely to increase in importance.
As always, it will be important to carefully consider how techniques used in other jurisdictions can be used in China. The process of currency liberalization is likely to have “Chinese characteristics” and, as such, direct application of techniques used in other jurisdictions may not be possible or may have unexpected consequences.