Company management of currency fluctuations in European Framework Projects

Increasing company participation in FP7 is a key goal, and for UK companies, there are special considerations to take account of with respect to the potential impact of currency fluctuations. Changes in the £/€ exchange rate can produce gains but also losses and few companies can afford to carry or absorb losses in any circumstances. This note explains the nature of the risks and strategies to mitigate them.

All FP projects receive pre-financing; this is transferred to the Coordinator (a University or industrial partner) normally in advance or at the time of the project start date. The level of pre-financing in FP7 is calculated from a formula which includes deductions for the Risk Sharing Finance Facility (RSFF) which was not present in FP6.

Put simply, the EC transfers pre-financing amounting to about 1.5 times the requirement to cover the budgeted costs for the first period. In a project with annual reporting periods (which has been the norm to date), the EC transfers budgeted costs for a period of 18 months of the project. More recently the EC has started to implement 18 month reporting periods, which means that it will transfer about 1.5 times the budgeted cost of the 18 months of the project, equivalent to around 27 months of funding.

It is normal practice for the Coordinator to convert the pre-financing from € to £ on receipt of the pre-financing. This is, of course, done at the rate prevailing at that time.

Project expenditure is made in sterling against a sterling budget.

It should be noted that there is no provision to use the exchange rate at the time of transfer of pre-financing.

Due to the practice of converting pre-financing shortly after receipt and before the majority of the costs are incurred there is a financial risk to the Coordinator from subsequent currency fluctuation.

Project PIs are likely to consider that a strengthening Euro means that they will have more pounds to spend as the grant is made in Euros. This would be the case if all costs were claimed retrospectively up to the contracted grant limit in Euros. However, as the grant is pre-financed there are two consequences depending on the direction of fluctuation following the conversion of the pre-financing into sterling.

If the Euro strengthens again the pound then spending only the budget in £’s converted from the pre-financing will mean that when exchanged back at the point of claim, expenditure of all the pre-financing will be insufficient to justify claiming all the pre-financing and the organisation would have to return Euros to the EC which it would have to find from another source. Alternatively, the project would have to incur additional eligible expenditure in £’s to maximise the grant claim and avoid returning funds to the EC.

If the Euro weakens against the pound then expenditure against the grant in €’s will be accelerated. Provided the activities described in the contract have been fulfilled, the excess sterling account funds will represent a surplus. This surplus could be spent against the project as there is no restriction on overspends or it could be used for other purposes.

An illustration of both these scenarios is provided in the tables appending this paper. A spreadsheet is available for modelling different exchange rate scenarios. It should be noted that the figures are not a detailed illustration as certain retentions are not included and expenditure is straight line.

Discussion:

This analysis suggests that an avoidable currency risk is taken at the point of conversion of pre-financing payments from €’s to £’s.

There is a significant potential upside and downside to this policy.

The risk could be largely mitigated by holding the pre-financing payment in a € account until the sterling costs are incurred. The higher the frequency of reconciliation the lower the risk would be.

When the beneficiary pre-financing is transferred from the recipient account used by the EC then any interest accrued is no longer recovered against the grant. Thus, a separate € account would be required.

A clear policy should define where responsibility for any shortfall lies or who the beneficiary of any excess is.