Clearwater Seadfoods Income Fund (Clearwater), which is a Canadian income trust, was the largest publicly traded shellfish in North America. Clearwater involved in catching, packing and selling a variety of shellfish to Canada and international markets such as America, Europe and Asia. During 2003 to 2005, unexpected change in foreign exchange rate caused Clearwater to face with the decline in revenue that led to the suspension of paying distribution to unit holders. Hence, it resulted in the decline of 35% to value of the units of Clearwater. Therefore, CEO of Clearwater – Robert Wight was determining an improvement strategy so as to restore the previous profit levels, distributions in addition to bring business back to prior growth phase.
Clearwater’s source of foreign exchange risk
Foreign exchange risk is defined as the potential loss to a trading of global businesses as a result of the unfavorable movement of foreign exchange rate. Clearwater faced with the foreign exchange risk based on the main sources presented as below.
Obviously, Clearwater was facing large risk exposure to the changing in foreign exchange rate. The reason for that is although Clearwater’s total operational expense were dominated in Canadian dollars, over 80% of total firm’s revenues, which were dominated in other currencies than domestic currency, were generated from locations outside Canada such as 33.8% from Europe, 30.5% from USA, 10% from Japan and 6.1% from Asia (based on exhibit 4,5). If Canadian dollar appreciates against other major currencies in which Clearwater generated revenue, the earnings of the trust will decline because of two reasons. Firstly, the stronger value of Canadian dollars, not only Canadian exporters and specially Clearwater but also lead to the smaller value of export sales after being converted into domestic currency. In fact in 2005, Clearwater’s revenue of CAD$17.6 million at total after being converted was less value than the amount in the case of without appreciation of the CAD. Secondly, As an exporter, Clearwater would face with the decrease in the number of orders from overseas as Clearwater’s products were more expensive compared with previous price in term of importers’ perspective. Hence, Clearwater’s customers would import products of Clearwater’s competitors who come from other countries. It can be called economic risk that impacts on Clearwater’s international competiveness. In fact, Clearwater loss nearly 10% of revenues from 2004 to 2005 as Canadian currency appreciated.
Clearwater’s foreign exchange risk management program had utilized forward contracts and options so as to hedge against the unfavorable change in Canadian currency. Based on forward contract, Clearwater just planned to hedge 50% of the forecasted revenues that means Clearwater still had to deal with remaining 50% sales which was not hedged. Thus, Clearwater would be able to earn excess profit from depreciation of Canadian dollar; however, it also could be a huge loss for Clearance if the unexpected change in exchange rate occurred. Moreover, Forward contracts which do not have clearinghouse that guarantee the transaction so that it exists a chance of default risk of counterparties who are not be able to commit their obligations. In term of option, Clearwater wrote call options on foreign currencies that means Clearwater prepared to buy Canadian dollars at a determined price, for instance CAD$1.5/USD. Therefore, Clearwater would gain premium income if Canadian currency appreciates; otherwise, they might suffer unlimited loss.
Translation risk is a risk occurs when accounting results from foreign earnings are translated into the domestic currency at the time of preparing financial statements. According to exhibit 8, Clearwater showed loss of 0.4% of total revenue in 2005 from foreign currency translation.
Clearwater’s business risk…