[King Dollar's Bombardment] Domestic Companies Actively Hedge Currency with Forward Contracts and Swaps... "Exports Will Soon Be Hedged Too"

Editor's Note

Despite the recent global trend of a 'King Dollar,' the depreciation of the Korean won has been particularly pronounced, and South Korea's foreign exchange reserves are rapidly decreasing. As foreign exchange reserves, which serve as a safety net for external payment settlements and crisis response during national economic emergencies, have shifted to a downward trend, debates over the adequacy of the reserve size have intensified. Currently, there are opposing views: one holds that South Korea's foreign exchange reserves fall short of the appropriate level estimated by major institutions such as the Bank for International Settlements (BIS), while the other argues that the current strong dollar phenomenon is a global common issue and should be viewed differently from the 1997 foreign exchange crisis. Accordingly, Asia Economy has gathered opinions for and against the appropriate level of foreign exchange reserves.

[Image source=Yonhap News]

Exchange rates have a significant impact on the activities of Korean companies, especially in exports and imports. The daily trading volume in the global foreign exchange market exceeds $5.3 trillion (approximately 7,311.35 trillion KRW), which is three times the size of South Korea's Gross Domestic Product (GDP). Not only financial institutions but also global companies are highly sensitive to changes in exchange rates.

◆Companies Hedge Currency Risk through Forward Contracts= According to the business community on the 7th, domestic companies are engaging in currency hedging (risk diversification) by trading derivative products such as currency forwards and swaps. A currency forward product refers to a contract and the product itself where a certain amount of a specific currency is agreed to be bought or sold at a predetermined price at a set future date. Forward contracts are used as a hedging tool to reduce exchange rate risk by buying or selling the contracted currency at a specific future time.

For export companies, fluctuating exchange rates can sometimes bring profits, but often cause significant damage to earnings, making exchange rate risk management a crucial corporate activity. Recently, more companies have been establishing dedicated departments to measure and manage exchange rate risk related to foreign exchange transactions.

Samsung Electronics manages exchange rate fluctuation risks through monitoring and handling foreign exchange transactions at regional financial centers in major overseas areas such as the United States, the United Kingdom, and Singapore. They manage liquidity risk by integrating funds within the region and hedge by trading currency forward products.

Hyundai Motor Company, which has a high export ratio, conducts transactions denominated in foreign currencies and is exposed to exchange rate risks across various currencies. Hyundai also adjusts the settlement dates of foreign currency fund supply and demand according to exchange rate forecasts and uses foreign exchange derivatives such as currency forwards, currency options, and currency swaps as hedging tools.

SK Innovation, which imports and processes most of its raw materials such as crude oil, regularly measures exchange rate risk internally. In particular, to hedge against exchange rate risks on foreign currency borrowings, it manages risk by entering into currency forward and currency swap contracts.

◆Exports Are Also a Form of Currency Hedging, but Large-Scale Investments Are a Burden= Domestic companies rely heavily on imports for raw materials such as crude oil and minerals but generate over 30% of their sales from exports. Their business structure inherently allows for currency hedging.

A business community official said, "Even if the majority of raw materials are imported, most intermediate goods manufacturers with export ratios exceeding 30-40% hedge their currency risk through exports. While increased exchange rate volatility is a risk, it is not a significant burden for companies with high export ratios."

However, companies facing large-scale investments in North America and Europe must bear both exchange rate and interest burdens, which is a concern.

Concerns are also growing in the domestic memory semiconductor industry, a key sector. The burden of raising investment funds is expected to increase for domestic semiconductor companies such as Samsung Electronics and SK Hynix, which are pushing for large-scale facility investments. Samsung Electronics is currently constructing a $17 billion (approximately 22 trillion KRW) foundry plant in Taylor, Texas, USA, and on the 19th of this month announced a large-scale investment of about 20 trillion KRW to establish the Giheung semiconductor research and development complex.

Since borrowing is inevitable to raise investment funds, Samsung Electronics' financial costs will inevitably increase with interest rate hikes.

Additional costs have also increased for securing raw materials. LG Energy Solution, a global leader in finished battery cells, had liabilities of approximately 4.2494 trillion KRW at the end of the second quarter of this year due to overseas joint ventures and successive investments. It is estimated that a 10% rise in the won-dollar exchange rate would result in a loss of about 160 billion KRW.