Managing Currency Volatility with Different Compensation Approaches
The unpredictability of fluctuating foreign exchange rates is a daily reality. For international companies, it can have a significant effect on employee compensation and the cost of running a business.
To say that 2017 has been a roller-coaster ride in the world of foreign exchange is an understatement. Whether it is the anticipation of the next policy move from the Trump Administration, Brexit and its impact on the British Pound, or the global impact from the once every 5 years Communist Party Congress, the events of this year have brought turbulence to foreign exchange across the globe.
Managing currency volatility is often a hot topic within Global Mobility. We work with our clients to help them incorporate and develop currency exchange protection strategies within their mobility policies.
We take into account their different compensation approaches, pay delivery systems, and company culture to help them incorporate strategies that are effective and sustainable over time.
In AIRINC’s latest finding from the 2017 Mobility Outlook Survey, 86% of the 130 global companies that participated in the study confirmed that they are still using the balance sheet approach or a reduced level of the balance sheet approach. This means that international assignees will remain on the home country payroll, but are provided differentials to compensate for cost-of-living differences between the home and host locations. The continuous use of the home-based approach means that currency protection measures are as relevant as ever.
While there is no perfect approach to dealing with currency fluctuation, there are three steps that international companies can take to limit its impact on expatriate compensation.
1. Start on the Right Note
The number one frustration that international assignees face in the wake of exchange rate volatility is that they do not understand how companies are handling the situation and how they are protected.
Assignees must be briefed on the type of assignment they are accepting, as well as the structure of their compensation and benefits. They must also come to an agreement with the company including when and how exchange rate reviews take place.
It is also important to help the assignees understand the purpose of Cost of Living Allowances (COLA) -- to protect employee purchasing power in the host location (not to provide incentive).
Furthermore, organizations should consider adopting a proactive communication approach to ensure that international assignees are involved in policy changes while on assignment. HR professionals and counsellors should also be able to justify and explain any new changes in policy.
2. Review and Update Regularly
Most companies surveyed have an existing policy and timeframe to review Cost of Living Allowances (most common being semi-annually). 58% of companies surveyed mentioned that they would conduct a review in the event that exchange rates fluctuate between four and six percent.
When changes happen abruptly, how flexible must corporations be in order to keep up?
In a notable example, a Malaysian national on assignment in the United Kingdom was impacted after a 30% decline in the Malaysian Ringgit against the GBP causing a COLA index change of 45% within a month and a half.
The decline of the Ringgit eroded the assignee’s purchasing power, and if the company did not look to adjust their allowance, the assignee would face significant financial losses that would eventually contribute to long-term employee dissatisfaction. In this instance, the mobility team had to ignore their customary timeframe for COLA reviews to respond to such a rapidly fluctuating exchange rate.
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3. Adopt a Split-Pay Approach or a Guaranteed Exchange Rate Strategy
While on assignment, employees are typically obliged to make payments or contributions to savings, insurance, and pension funds at the home country. Since the employee will be sending money home as part of this arrangement, any changes in exchange rates and inflation can affect them significantly.
One good way to mitigate this issue is to adopt a Split-Pay Approach. In a Split-Pay Approach, a portion of the assignee’s salary is paid at home to cover these obligations, while the remainder is paid at the host location to pay for goods and services and housing expenses.
Keep in mind that when using a Split-Pay Approach the corporation and the assignee should agree to a proper proportion of home versus host salary, and also a schedule to review the split and re-calibrate if necessary.
Some companies also use the Guaranteed Exchange Rate strategy. Through this approach, the company and the assignee agree to pegging the currency at a certain rate over a period of time so that any exchange rate changes would not have any impact on the assignee’s pay.
Regardless of the strategy you choose, a successful currency management program requires communication, flexibility, and a solid policy framework.
Strong stakeholder support is fundamental to any effective global mobility program so organizations must strive to educate international assignees on procedures and policies. An educated expat, the right policy for your business, and the right level of flexibility will help you weather the storm of fluctuating exchange rates, keeping assignees happy and avoiding costly overpayment for the company.
AIRINC helps companies address expatriate compensation and mobility issues in a complex and ever-changing global environment through thought-leading advisory services, high quality data services, and leading-edge technology solutions.