Exchange rate impact

Why does CERN hardly ever gain money on exchange rate differences with EU projects

Have you ever wondered why EUfin keeps a portion of the overheads to cover the exchange rate risk on EU projects ? "Where does this money go ?" you might ask. "And why does EUfin never return exchange rate gain ?"

Well, the money actually goes… nowhere ! (I mean, on a budget point of view) As it is meant to cover the difference between the actual spending on EU projects (i.e. the budget granted) and the real value of the contribution in EUR, the retained overhead portion is registered in accounting as EU revenues, like the rest of the contribution. Then, EU revenues (including the overhead) are balanced with the actual spending on EU projects.

As the exchange rate variation randomly impacts EU projects (different funding mechanism, reporting periodicity, payment dates, etc.), the "EU revenues vs EU spending" check is not performed per project, but overall.

This is why no money is returned after the end of the project. Ultimately, some projects will have contributed more than their actual exchange rate loss, some will have contributed less, but overall, the Organization will be even. This "solidarity" principle allows to level the risk per project. To do so, the portion of overheads retained has been computed based on the statistics (exchange rate variation, period and project's duration, etc.) over the last five years.

Finally, you might also wonder "Why don't the exchange rate gains and losses eventually even out ?" The answer is simple: because there is hardly ever exchange rate gain on an EU project. I know what you think: "If the CHF goes up, the EUR we receive are worth less CHF, hence we lose money. However if the CHF goes down, the EUR we receive are worth more CHF, and we gain money."

In a way, you are right. But this is only the tip of the iceberg.

Let's imagine that I give you a check of 100€, that you can cash in only in 2 years. You decide to spend  125 CHF today, hoping that you will be reimbursed by cashing the check later. In two years, if the exchange rate is lower than 1€ = 1.25 CHF (the CHF is stronger), you have an exchange rate loss. If it's higher (the CHF is weaker), you have an exchange rate gain. Simple. You probably wish for the CHF to weaken.

Now, let's imagine that I promise you up to 100€ in 2 years, only if you can justify that you did spend them in CHF, and using an exchange rate that will be known only in two years. During the two years, you spend 125 CHF.

Two options:

  1. In two years, the exchange rate is 1 EUR  = 1.20 CHF: you justify having spent 104.2 €. I give you 100€ as promised (not 104.2€ !) that you convert immediately. You get 120 CHF. You have lost 5 CHF.
  2. In two years, the exchange rate is 1 EUR  = 1.30 CHF: you justify having spent 96.2 €. I give you 96.2 € that you convert immediately. You receive 125 CHF. You're even.

Two options, but no exchange rate gain; only loss or 0. You still wish for the CHF to weaken, though.

Now, let's change the "cashflow" rule: I still promise you up to 100€, only if you can justify that you did spend them in CHF, and using an exchange rate that will be known only in 2 years. However, this time I give you 60 € today; the rest in 2 years. You convert the 60€ at 1.25. You have 75 CHF. During the 2 years, you spend 125 CHF.

Again, two options:

  1. In two years, the exchange rate is 1 EUR = 1.20 CHF: you justify having spent 104.2 €. I owe you 100€ - 60 € = 40 € that you convert immediately. You get 48 CHF, in addition to the first 75 CHF, i.e. 123 CHF. You have lost 2 CHF.
  2. In two years, the exchange rate is 1 EUR = 1.30 CHF: you justify having spent 96.2 €. I owe you 96.2 € - 60 € = 36.2 € that you convert immediately. You get 47.1 CHF, in addition to the first 75 CHF, i.e. 122.1 CHF. You have lost 2.9 CHF.

 

Do you still wish for the CHF to weaken ?

Indeed, the exchange rate difference on EU projects is caused by various parameters. Namely:

  1. The exchange rate retained at the beginning of the project (budget rate)
  2. The exchange rates for each EC payment (prefinancing, interim payments, final payment)
  3. The exchange rates at reporting time (used to "invoice" the EC)
  4. The EC maximum contribution

 

Still not convinced ?

Here you will find 2 different scenarios for one EU project.

The EC grant is 1,000€. The project has a duration of 48 months, with 2 reporting periods. The prefinancing is 60% of the grant.

The exchange rate retained at the beginning of the project is 1€ = 1.2600 CHF, same as the prefinancing. The total budget in CHF is therefore 1,260 CHF, spent equally over the 2 periods.

Scenario 1: The CHF weakens throughout the project

Month Xchange rate   CHF
0   EU grant 1'000  
0 1.2600 Internal budget   1'260
0 1.2600 Prefinancing 600 756
24   Spending   630
24 1.2850 Costs declared to EC (P1) 490.3  
26 1.2900 Interim payment* 250 322.5
48   Spending   630
48 1.3100 Costs declared to EC (P2) 480.9  
50 1.3200 Final payment 121.2 160
  Total spent     1'260
  Total declared to EC   971.2  
  Total payment received   971.2 1'238.5
  Exchange rate difference     -21.5

* Prefinancing + Interim payment cannot exceed 85% of the maximum EC contribution 

Due to the evolution of the exchange rate at reporting time (months 24 and 48), Cern has declared less € than the maximum EC contribution (971.2 € < 1000 €). Cern will receive 28.8 € less than expected.

The loss is partially compensated as the CHF kept weakening between months 24 and 26, than 48 and 50. However, this if insufficient to compensate the loss between months 0 and 24, then months 0 and 48.

Ultimately, Cern has spent 1260 CHF and received 1238.5 CHF. The exchange rate loss is 21.5 CHF.

Conclusion: As the CHF weakens, Cern will declare less spending to the EC over the years.  By the end of the project, the money received will not allow to cover the budget granted at the beginning of the project. 

Scenario 2: The CHF strengthens throughout the project

Month Xchange rate   CHF
0   EU grant 1'000  
0 1.2600 Internal budget   1'260
0 1.2500 Prefinancing 600 750
24   Spending   630
24 1.2350 Costs declared to EC (P1) 510.1  
26 1.2300 Interim payment* 250 307.5
48   Spending   630
48 1.2100 Costs declared to EC (P2) 520.7  
50 1.2000 Final payment 150 180
  Total spent     1'260
  Total declared to EC   1'030.8  
  Total payment received   1'000 1'237.5
  Exchange rate difference     -22.5

*Prefinancing + Interim payment cannot exceed 85% of the maximum EC contribution 

Due to the evolution of the exchange rate at reporting time (months 24 and 48), Cern has declared more € than the maximum EC contribution (1031 > 1000). 

However, the EC will not pay more than the maximum contribution. Cern will receive 30.8 € less than actually justified. 

Ultimately, Cern has spent 1260 CHF and received 1237.5 CHF. The exchange rate loss is 22.5 CHF.

Conclusion: As the CHF strenghens, CERN will declare more spending to the EC over the years. However, EC's reimbursement will be capped to the maximum contribution. The € received as interim and final payments are also worth less CHF than expected. By the end of the project, the money received will not allow to cover the budget granted at the beginning of the project.

 

In which case(s) could we have an exchange rate gain ?

There are only a few situations in which we could have an exchange rate gain.

  1. In the above scenarios, a sudden and significant drop of the CHF between months 24 and 26, then 48 and 50, could result in an exchange rate gain, leaving a very small window of opportunity.
  2. In scenario 2, a significant underspending may generate an exchange rate gain (whereas it would increase the loss on scenario 1). Again, this is unlikely to happen, as the underspending of a beneficiary of an EU project generally generates a budget redistribution amongst beneficiaries. 

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Updated on: 30/03/2016