European automakers ramp up renminbi hedges as Russia threats mount
VW, BMW, Mercedes and Stellantis added an additional €70bn in FX hedges in 2021 to protect growing export revenues, but geopolitical risk could threaten this strategy
Europe’s automobile giants, Volkswagen, BMW, Mercedes-Benz and Stellantis boosted foreign-exchange hedging in 2021, mainly the Chinese renminbi as they anticipate selling more cars in China, their largest export market.
The increase in FX hedging comes as geopolitical risks threaten to derail the underlying cash flows, removing the accounting justification for the hedge. The economic sanctions placed on Russia after its invasion of Ukraine in February 2022 forced automakers to suspend operations in the region.
In 2021, Wolfsburg based, Volkswagen (VW) and its brands Audi, Skoda, and Porsche delivered 927,000 electric vehicles in China, four times higher than a year ago, contributing 15.3% to its consolidated operating profits. As the company expects the growth momentum to continue, it aims to locally produce cars to fulfil the growing Chinese demand.
However, as it waits for new factories to get up to speed, VW will have to export cars to China which are built in Europe. This poses a growing risk management problem and any adverse movement in the Chinese renminbi against the Euro can result in deterioration of profit margins for VW.
To mitigate this, VW added €27.6 billion in FX hedges, taking the notional amount to an all-time-high of €131.5 billion, which when expressed as a proportion of foreign sales equates to 63.9%, highest since 2017. The majority of increase in FX hedges is estimated to come from contracts in CNY and GBP pairs, as per EuroFinance’s analysis of 2021 disclosures.
“We are shifting car production to regions such as China and the Americas” said Herbert Diess, CEO at VW during a March 15th earnings call.
In May 2020, the company increased stake in its Chinese joint venture to 75% while also acquiring a 26% stake in battery manufacturer Gotion High-Tech.
The hedge increase comes as VW shakes up its treasury management team. In November 2021, the company announced that it will combine Group Treasury and Investor relations which will be led by Rolf Woller, replacing Dr. Jörg Boche who retired as VW head of treasury at the end of 2021.
Stuttgart-based Mercedes-Benz, previously known as Daimler before it spun-off Daimler Truck holding, also followed suit as it hedged 69% of its forecasted cash flows in Chinese renminbi, higher than 48% a year ago. Its notional FX hedges increased by 21%, or €6.6 billion to €36.9 billion at the end of 2021, while its hedge ratio stood at 36.2%.
“The increase in notional FX hedges was mainly driven by strong foreign currency revenue increases after temporary decreases due to the pandemic” a Spokesperson at Mercedes told EuroFinance
He further said, “In case of favourable market development and higher certainty of expected FX revenues, decisions concerning hedging ratios and hedge horizons are revised. This led to an increased hedged ratio for the underlying forecasted cash flows in Chinese renminbi at year-end 2021 compared to 2020.”
While the company plans to accelerate production of electric vehicles in China this year, FX hedges will mitigate risk arising from a higher cash inflow in Chinese renminbi when vehicles are sold in China against a cash outflow in Euro when the vehicles are manufactured in Europe.
BMW also followed suit as in February, it increased stake in its Chinese Joint venture, BMW Brilliance Automotive from 50% to 75%. While its FX notional hedges also increased to €33.6 billion in 2021 from €16.5 billion a year ago, sufficient to cover half of its international sales during the year.
According to a BMW spokesperson, “The BMW Group follows a selective valuation driven FX hedging strategy. Due to the EUR weakness in 2021 the hedge ratios increased compared to 2020.”
Meanwhile, In the long run, vehicles produced in China to be sold locally will create a natural hedge against FX movements as despite significant sales from international markets, automakers will be able to generate operating expenses in the Chinese renminbi, resulting in a smaller base of exposure at risk.
Looming geo-political risks
After Russia’s invasion of Ukraine in February, countries around the world are imposing economic sanctions against Russia. As a result, many automobile manufacturers had to limit, halt or fully exit business activities in Russia as they also suffered from raw material shortages from suppliers in Ukraine. In response, automakers shifted manufacturing to other regions including China in order to compensate for the lost production.
A larger FX hedging portfolio built before the start of the year will help to stave off the foreign exchange risk from the rising currency exposure as expenditure to build cars will be done in a currency other than which sale will be made.
Amsterdam based- Stellantis, which was formed after a merger between Fiat Chrysler and PSA Peugeot last year, had commenced production at a factory in Russia with an aim to make it a low-cost export hub for light vans and further triple its volumes in the Eurasian region by 2021. But now, the Ukraine crisis has left the Stellantis plan to export units from its plant in Russia on indefinite hold.
In 2021, the company increased its FX hedges to €25.6 billion, as compared to only €6.9 billion a year ago, resulting in its hedge ratio to increase from 9.4% to 26.3% during the same time period.
It is also important to note that a geopolitical risk looms over automobile manufacturers that if China’s support towards Russia over Ukraine’s invasion leads to further economic sanctions by the western countries.
Currently, Mercedes’s Russian subsidiaries hold total assets worth €2 billion and while economic sanctions against Russia prevail, these investments are at risk.