020 7898 0500
Smart Currency Business can help you manage your currency risk
If you’ve been doing this for as long as we have, you’ll come across many clients who share similar FX problems. That’s true for all business sectors and both large and small companies.
Unfortunately, these problems can often be costly, but our experience means we can help. In this article, we’ll explain how we can help you to manage your currency risk.
Once you’ve had a read, get in touch today to see how we can help you.
1. Know the extent of your foreign exchange exposure
Our first piece of advice is to appreciate the extent of your foreign exchange exposure in relation to your costs, turnover and profits. For example, a net-exporter is detrimentally affected when their home currency increases in value. If the contribution of export revenues to total turnover is relatively high, the exposure and potential risks are greater.
Early in the process, your Account Manager here at Smart will talk you through the factors that can affect currency markets. It is important to do this before taking any further steps. Failing to account for volatile currency movements can lead to disastrous consequences.
2. Don’t let markets influence strategic decisions
The foreign exchange market is by far the biggest global financial market, with daily trading volumes in excess of $5 trillion. Please do take a look at our Quarterly Forecast, which spotlights key currencies and shares predictions from some of the market’s most knowledgeable sources.
Markets move quickly, driven by sentiment, rumour, economic data releases, central bank comments and political rhetoric to name but a few factors. In an age of high frequency trading, it’s common to see big swings (we call this ‘price action’) of 1-2% in an afternoon. If you have a view on the direction of currencies we strongly urge you not to take it into the boardroom. The currency market is entirely outside of your control and prices reflect all available information.
We always encourage strategic decision makers to consider the chain of accountability within the organisation and to ensure bets are left in the casino and not on your balance sheet. Our experts can put a reliable strategy in place, enabling you to make informed decisions that offer certainty.
3. Work to a structured risk management policy
Every organisation should have a clear process that defines their approach to risk management. As a minimum, a good policy will include authorities and responsibilities, strategic objectives, how risk is measured, and how risk is managed. The team at Smart have developed the Smart FX Policy Template which we can customise to your individual needs.
A sound policy gives a framework and sets the objectives for risk management. The strategy is just one part of the policy, but it’s important that the strategy aligns its KPIs to the goals of the business. This will give the policy a clear direction.
4. Define your risk management objectives
Objectives provide a clear platform to measure the strategy’s performance. We strongly advocate for setting objectives that align to business goals. For example, if the organisation has a goal of improving its credit and liquidity position, then a strategy which could cause a drain on cash would be inadvisable. Alternatively, consider a business with specific investment and scaling targets; a well-aligned risk management objective would be to protect operating profit margins at budgeted levels. In turn, this would dictate the tolerable level of risk and therefore the type and amount of hedging that fits that criteria.
5. Focus on the risk to P&L, not the rate
The foreign exchange market provides ample potential distractions to decision-makers, evidenced by the sheer volume of speculators participating in trading activities. We have found over the years that intraday currency movements can be hypnotic, and often prolong decision-making. We’ve seen that operating without a clear policy can allow for opinion and subjectivity to take over.
It’s tempting to let rates drive decisions, but the potential risks to business due to an action (or inaction) should be at the forefront of strategy. We can advise you on how best to implement a hedging strategy for your company, based on our analysis of your exposure and positions.
6. Simplify your hedging
Hedging doesn’t have to be complex, and we find that when managing risk it’s a good idea to keep things simple. Less really is more! Why do we take this approach? Because the simpler the hedge, the easier it will be to revalue, which is key to knowing your overall position and assessing your risk. More complex trades are also more difficult and costly to exit, pre-deliver or extend.
Luckily, our Smart Hedge platform lets you visualise your exposures, taking the stress of hedging out of your hands. Give one of our account managers a call today to see how we can help you simplify your hedging strategies.
7. Factor in cash-flow
We advocate an approach that links hedging strategy to business objectives, and we understand that cash is the lifeblood of business. Therefore, we believe it’s important to carefully consider how any hedging transactions could impact your access to liquidity throughout any contract’s life cycle.
If cash is tight, or forecasted to be so, then it makes sense to consider products that minimise exposure to negative Mark To Market (MTM) risk. Of course the potential risk of not hedging is usually significantly larger than MTM exposure, but it pays to take into account your potential future exposure as part of your overall hedging policy. Smart’s market-leading position monitoring and analysis tools can help you plan effectively, with position sensitivity analysis highlighting future cash pinch-points, reliable MTM reporting and valuations, and risk management policy analysis and compliance reporting.
8. Don’t discount internal risk mitigation opportunities
The first port of call for foreign exchange risk mitigation is to avoid foreign exchange altogether. If revenues are generated in the same currency as expenses are incurred, this presents a natural hedging opportunity. There may be differences in the timing of cash-flows, which might make a perfect hedge difficult or impossible, however there are solutions to manage this risk in a cost-effective way.
Currency exposure netting is a somewhat different concept to natural hedging. Global businesses can also operate a central treasury and utilise inter-company multilateral netting. This means payments and receipts from a group’s global entities are managed centrally and net payments are made, therefore reducing exposure levels at subsidiary/local entity level. For example, if a UK company importing has import costs in US dollars but also has a US office generating revenues in dollars, the company may be able to match the cash-flows.
It is always important to consider the different ways in which your risk can be reduced naturally. Often there are ways to offset risk by matching suppliers and sales in the same country, or to ask suppliers to pay you in your own currency. Matching the cycles of your payments and receipts is a good way to avoid risk.
9. Consider derivatives reporting and potential volatility in P&L
A derivative is a financial contract with a value derived from an underlying asset – in foreign exchange this is the underlying spot price for a given currency. Derivatives contracts include futures, forwards, and options. The prevailing value, or Mark-To-Market (MTM) value, of derivatives contracts must be reported in annual financial statements, which can lead to unexpected volatility in P&L.
Using derivatives is not always as straightforward as it appears. Sometimes the derivative will have to be accounted for separately, even being split up into different parts – ‘time value’ and ‘intrinsic value’. This can actually lead to more, rather than less, P&L as the derivative shows up in different sections of the accounts to the exposure being hedged. Smart can assist in providing guidance around the accounting of various hedging instruments, and propose solutions that minimise earnings volatility, so that your company meets its financial objectives.
10. Understand all of your hedging solutions
The potential toolbox of hedging strategies is vast and the choices can be mind-boggling. What’s more, the prevalence of aggressive selling of potentially inappropriate or unsuitable trade types to businesses is commonplace, meaning negative client outcomes occur all too often. We take a client-first approach where driving positive outcomes for customers, aligned to company objectives is paramount.
Once your Smart Account Manager has fully understood the requirements of your company and you have created a risk management strategy together, you can then learn about all of the hedging solutions available to you.
To make sure your upcoming transactions are protected against the risks of sudden market movements, call your Account Manager on 020 7898 0500 to discuss a forward contract; alternatively, if you’re new, please register with Smart Currency Business today.
