Bring FX Out of the Dark

Have you revisited your FX strategy following the Brexit vote? Now could be a good time for businesses to consider their FX position – but rather than just minimising potential risks, businesses should also be capturing FX opportunities. Stephen Haughey, Director, Global Markets Corporate Services at HSBC explains more.

Brexit has already done much to focus the minds of business leaders and finance professionals alike. Companies are rightly reassessing their business strategies and investments, and seeking new ways to capture growth.

And as exchange rate volatility since the EU Referendum has highlighted, a key part of that review process should be tweaking the company's FX strategy (or indeed implementing one for the first time). After all, FX can have a significant impact on any business, either positive or negative.

Windfall gains

For UK exporters, recent currency movements have been favourable. "The weaker sterling that we have seen since June means that outbound goods and services have become cheaper for overseas buyers. As such, UK exports are likely to generate considerably more income than forecast," notes Haughey.

While some businesses will simply accept this windfall gain, Haughey maintains that FDs should be thinking about ways to ensure that the business can continue to benefit from today's advantageous FX rates throughout the coming 12-24 months. "Currency hedging products such as forwards and options, used as part of a balanced FX strategy, are one way to consider doing this."

The business impact

Elsewhere, Haughey believes it is time for companies to consider how recent changes in the FX market – together with bolstered income streams from exports – will impact the wider business. "What many people don't realise is that FX and business performance are intrinsically linked, so they should not be viewed in isolation," Haughey cautions.

Rather than just settling for the larger profit, he suggests that exporting companies might consider thinking more broadly about how a windfall gain from recent currency movements may influence their business strategy going forward. Could the additional funds be used to re-negotiate supply chain relationships? Should the company now be looking to grow the international side of its business faster than the domestic market? And for those companies not yet exporting, could now be an ideal time to re-consider trading abroad?

Taming volatility

For UK importers, on the other hand, a weaker sterling means that buying stock from overseas is now significantly more expensive than many had envisaged at the start of 2016. "Unfortunately, a number of importers may be beginning to struggle because they didn't have an FX strategy that gave them enough protection for this kind of currency movement," says Haughey. "For them, the immediate priority will be looking for ways to combat the twin effects of higher import costs and lower margins."

Although some importers may be in a position to immediately flex their pricing with suppliers or begin to source domestically again, many won't have that luxury. "However, FX products such as forwards and options can be used to help minimise further currency losses. And if companies already have FX hedges in place, these can easily be restructured to spread the 'pain' across a longer time horizon." As a result, the importer can adjust their pricing over a more reasonable time period, which should be less damaging to their supply chain.

Time for action

So, no matter how big an impact currency movements are having on your company, there are always products available to help regain control. And while managing currency risk might seem like a dark art, in reality it is neither complicated nor expensive. "In fact, doing nothing about the company's FX exposures is often the costlier decision," warns Haughey. "That's why having an FX strategy is so important."

Through a tailored mix of spot FX, forwards and options, an FX strategy will look to combine protection – even for unexpected events – with the ability to benefit from favourable market movements.

Another important hallmark of a solid FX strategy is that it is linked to the company's business plans.

"Ultimately, a significant change in the FX market, such as we have seen after the UK's vote to leave the EU, should prompt businesses to think again about the way they are operating. That doesn't mean that FX rates should completely dictate a company's FX strategy or growth strategy, but neither should currency movements be ignored or written off as an unavoidable by-product of trading internationally."

Forwards and options explained

A forward contract allows a business to fix the foreign exchange rate in advance. This provides certainty and protection should rates move in the wrong direction. However, as the exchange rate is "fixed" for a future date, the business has to be comfortable to forego potential gains if rates move favourably.

A more flexible alternative is a currency option. Here the business specifies the worst protected rate they would accept and the currency exchange is protected at that level. If the exchange rate moves against them, they can still deal at the protected rate, but if rates move in their favour, they can deal at the more advantageous spot rate. An upfront premium is usually payable for a currency option although a range of nil-premium products is available.

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