We are trying to determine an effective currency exchange (FX) rate for our upcoming expat assignment. Specifically, we were wondering what FX rate we should use when setting and updating COLA and other assignment allowances? Should we use the rate from the day the assignment starts? Or rather a 3 month/6 month/12 month average?
Dear Global Mobility Manager,
I can understand your company’s and your assignee’s nervousness around exchange rates lately, especially given the recent burst of global currency volatility. Based on what I have seen, the most common practice is for companies to set somewhat frequent update periods (quarterly is best but semi-annually is ok too) and use the most up-to-date rate available on that day.
I have asked one of my industry colleagues who is a subject matter expert in this area to provide a more meaningful explanation of why it is best to use the most current rate possible when determining the FX exchange rates for international assignments. Jordan Blue is a Senior Associate at Mercer and has this to say:
For FX rates we typically recommend that you use the most current rate possible. At first thought, it would make a lot of sense to use an average, right? But when we consider which approach would get closest to truly equalizing the salary the average doesn’t work out so well. Essentially, using an average means you include a lot of data points that simply aren’t relevant to our purpose.
If you think about it, our purpose is to set the COLA for the next quarter or 6 months based on what we believe the FX rate will be. In other words we want to try and predict the FX rate moving forward. If I want to know what the FX rate will be tomorrow my best reference point is today’s FX rate. Using an average would likely put me way off (consider the graph below). The average FX over the past year would be somewhere around 1.25 but the FX rate tomorrow is likely to be somewhere around 1.35 which is a big shift. Even if we used a 3 month average we would still be around 1.3 which is again, pretty far from where we want to be. So while using an average seems like a great idea, it actually means the assignee won’t be equalized due to the difference in the FX rate we use to calculate the COLA and the FX rate they actually experience when they transfer money.
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