Editors' Note: This article, and others in this series were originally published in a whitepaper from HiFX, entitled "The HiFX Guide to Managing Currency Risk - Nine Foreign Exchange Mistakes Your Business Should Avoid".
Now that the HiFX team has joined forces with XE, we are re-branding and refreshing this content. Many customers told us they found the original version of this content to be both enlightening and engaging. We hope it inspires and interests you as well.
All businesses, with any exposure to international currencies can find it challenging to manage foreign exchange risk. Smaller businesses, immersed in the day-to-day operations of running their firms and lacking specialist staff may lack the time and the expertise needed to build a thorough understanding of the nuances of foreign exchange.
Larger businesses may have many other priorities that prevent them taking a strategic view of currency risk. While it may be tough to manage foreign exchange, the costs of failing to do so are potentially very high – all the more so given the uncertain times in which we currently live.
In the aftermath of the UK’s original vote to leave the European Union, the value of the pound against the dollar fell 12 per cent within hours. Three months later the figure had reached 15 per cent*. That can be devastating for a business with FX exposures. When the "meaningful vote took place on the 15th of January 2019, the Brexit separation deal was soundly defeated in UK parliament. GBP held steady initially after the vote closed, and PM Theresa May and her cabinet survived a vote of no-confidence.
In fact, the world’s foreign exchange markets are often volatile and sometimes extremely so. The reaction to Brexit was certainly unusually strong – that 12 per cent one-day drop is a typical trading range for sterling over a whole year is rare, but far from unprecedented.
XE supports thousands of businesses a year, all around the world. We believe they manage their foreign exchange and plan ahead to mitigate the dangers of this kind of volatility. But many more are not confronting this challenge – and making the same mistakes over and over again. In this guide, we set out to identify those mistakes, not least to help more businesses avoid them in the future.
This is not to suggest that all businesses face the same issues. Smaller businesses just getting started with international trade, whether importing or exporting, may be overwhelmed by the decisions they need to make and struggle even with short-term choices. Meanwhile, larger businesses may be more sophisticated, with basic systems in place to manage day-to-day currency transactions, but they often lack a clear idea of the bigger picture, or how to manage risk holistically.
Both types of business are vulnerable to many of the mistakes detailed in this guide. But the biggest mistake of all may be failing to realize that you’re not on your own here – for while parts of foreign exchange may be daunting, professional advice and service will help. Some businesses choose to get their support from their banks, but an increasing number are opting to work with specialist advisers such as foreign exchange brokers, which focus purely on currency.
In short, all businesses have an opportunity to learn from their mistakes – and in this bumpy environment, now is the time to do so. This guide can help you start the process.
When you don't know if you’re exposed to foreign exchange risk,or by how much
Many businesses, particularly at the smaller end, are not aware they have an exposure to foreign exchange risk. Even if they are, they have never quantified the size of the risk they face. If you’re in that position, it is more likely that the impact of currency market volatility on your business will come as a nasty shock.
Currency market exposure comes in different forms. Any business selling goods and services overseas will be concerned that a rise in the value of the pound could damage their competitiveness in those markets.
Conversely, if you’re importing anything from overseas – raw materials, for example – a fall in the value of sterling will make those imports more expensive.
Equally, don’t forget balance sheet risk: many UK businesses have international subsidiaries and entities that do their day-to-day business in another currency. If so, the value of those operations, when accounted for by the UK head office, will be affected by exchange rate movements.
The important principle here is to recognize that a risk exists and then try to assess its potential size. That will require you to make some quantitative assessments, but also some qualitative judgement.
For example: A business that imports €100,000 of European goods each year isn’t exposed to €100,000 of currency risk. The GBP/EUR exchange rate isn’t going to fall to zero. In other words, assessing the true value of your exposure going forward will require you to make some estimates of how much volatility in the currency markets is likely – you might do that, for example, by looking at the range in which rates have moved in the past.
In chapter two of this series, we'll explore the ramifications of not implementing a foreign exchange risk management policy.
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