Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Foreign Currency and Derivative Risk
We have global operations and substantial portions of our revenues, expenses, assets and liabilities are generated and denominated in non-U.S. dollar currencies.
The following table shows the percentage breakdown of our revenue and operating expenses denominated in currencies other than the U.S. dollar for the years ended December 31, 2022, 2021 and 2020:
Year Ended
December 31,
2022 2021 2020
% of revenue denominated in foreign currencies (1)
28% 29% 29%
% of operating expenses denominated in foreign currencies (2)
15% 15% 14%
(1) Revenue in foreign currencies is primarily denominated in euros.
(2) Operating expenses in foreign currencies are primarily denominated in British pounds sterling.
Revenues, expenses, assets and liabilities denominated in non-functional currencies are recorded in the appropriate functional currency for the legal entity at the rate of exchange prevailing at the transaction date. Monetary assets and liabilities that are denominated in non-functional currencies are then remeasured at the end of each reporting period at the exchange rate prevailing at the end of the reporting period. Foreign currency remeasurement gains or losses on monetary assets and liabilities in nonfunctional currencies are recognized in the consolidated statements of income within general and administrative expenses. Realized and unrealized gains/losses from foreign currency re-measurement of transactions in nonfunctional currencies recognized in the consolidated statements of income within general and administrative expense totaled a $2.3 million loss, a $4.0 million loss and a $1.3 million gain for the years ended December 31, 2022, 2021 and 2020, respectively.
Since our consolidated financial statements are presented in U.S. dollars, we also translate all non-U.S. dollar functional currency revenues, expenses, assets and liabilities into U.S. dollars. All non-U.S. dollar functional currency revenue and expense amounts are translated into U.S. dollars monthly at the average exchange rate for the month. All non-U.S. dollar functional currency assets and liabilities are translated at the rate prevailing at the end of the reporting period. Gains or losses on translation in the financial statements, when the functional currency is other than the U.S. dollar, are included as a component of other comprehensive income. Accordingly, increases or decreases in the value of the U.S. dollar against the other currencies will affect our operating revenues, operating income and the value of balance sheet items.
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Aside from U.S. dollars, a significant portion of our revenues are denominated in euros and a significant portion of our expenses are denominated in British pound sterling. The following table shows the average foreign currency exchange rates to the U.S. dollar for the years ended December 31, 2022, 2021 and 2020:
Year Ended
December 31,
2022 2021 2020
Euros $ 1.05 $ 1.18 $ 1.14
British pound sterling $ 1.24 $ 1.38 $ 1.28
The following table shows the change in revenue and operating income caused by fluctuations in foreign currency rates used in translation during the years ended December 31, 2022, 2021 and 2020:
Year Ended
Impact of Foreign Currency Rate Fluctuations (amounts in thousands) December 31,
2022 2021 2020
Increase (decrease) in revenue $ (38,300) $ 11,300 $ 4,500
Increase (decrease) in operating income $ (26,200) $ 5,200 $ 4,000
The following table shows the impact a hypothetical 10% increase or decrease in the U.S. dollar against all other currencies and a hypothetical 10% increase or decrease in only euro or only British pound sterling exchange rates would have on the translation of actual revenue and operating income for the years ended December 31, 2022, 2021 and 2020:
Year Ended
Hypothetical 10% Change in Value of U.S. Dollar (amounts in thousands) December 31,
2022 2021 2020
All currencies
Effect of 10% change on revenue +/- $ 36,400 +/- $ 34,900 +/- $ 28,900
Effect of 10% change on operating income +/-
$ 23,800 +/-
$ 23,000 +/- $ 18,900
Euros
Effect of 10% change on revenue +/- $ 33,300 +/- $ 32,000 +/- $ 26,300
Effect of 10% change on operating income +/- $ 32,100 +/- $ 31,000 +/- $ 25,900
British pound sterling
Effect of 10% change on revenue +/- $ 1,400 +/- $ 1,500 +/- $ 1,300
Effect of 10% change on operating income +/- $ 8,500 +/- $ 7,700 +/- $ 7,100
We have derivative risk relating to our foreign currency forward contracts. We enter into foreign currency forward contracts to mitigate our U.S. dollar and British pound sterling versus euro exposure, generally with a duration of not more than 12 months. We do not use derivative instruments for trading or s peculative purposes. As of December 31, 2022 and 2021, the notional amount of our foreign currency forward contracts was $162.8 million and $146.2 million , respectively. Realized and unrealized gains/losses on foreign currency forward contracts totaled a $4.9 million gain, a $9.0 million gain and a $6.3 million loss for the years ended December 31, 2022, 2021 and 2020, respectively.
By using derivative instruments to hedge exposures to foreign currency fluctuations, we are exposed to credit risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. When the fair value of a derivative contract is negative, we owe the counterparty and, therefore, we are not exposed to the counterparty’s credit risk in those circumstances. We attempt to minimize counterparty credit risk in derivative instruments by entering into transactions with high-quality counterparties whose credit rating is at least upper-medium investment grade.
Credit Risk
We have credit risk relating to our receivables, which are primarily receivables from financial institutions, including investment managers and brokers and dealers. As of December 31, 2022 and 2021, the allowance for credit losses with regard to these receivables totaled $0.1 million and $0.3 million, respectively.
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In the normal course of our business we, as an agent, execute transactions with, and on behalf of, other brokers and dealers. If these transactions do not settle because of failure to perform by either counterparty, we may be obligated to discharge the obligation of the non-performing party and, as a result, may incur a loss if the market value of the instrument is different than the contractual amount. This credit risk exposure can be directly impacted by volatile trading markets, as our clients may be unable to satisfy their contractual obligations during volatile trading markets.
Our policy is to monitor our market exposure and counterparty risk. Counterparties are evaluated for creditworthiness and risk assessment prior to our initiating contract activities. The counterparties’ creditworthiness is then monitored on an ongoing basis, and credit levels are reviewed to ensure that there is not an inappropriate concentration of credit outstanding to any particular counterparty.
During the year ended December 31, 2022, we also recognized losses totaling $1.0 million, related to the write-off of an investment that was determined to be uncollectible.
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