Published: May 01, 2014
AFEX, one of the world’s largest non-bank providers of global payment and risk management solutions, announced the results of its inaugural Currency Risk Outlook Survey recently, indicating that a vast majority (88%) of its clients in the US, UK and Australia foresee currency movements to be as or more volatile in the next 12 months than the preceding year. The survey polled 452 businesses around the world and found that half of the respondents will employ a hedging strategy in 2014, with more than a third (35%) expecting to hedge more than they did in 2013.
The end of the first decade of the 21st century saw currency markets experience volatility, as first the sub-prime loan crisis rattled long-standing Wall Street institutions and then the Eurozone crisis took root. These events served as a perfect storm to undermine the global financial system, in turn forcing the hands of central bankers to manipulate their interest rates and currencies in the hope of reviving stagnant economies.
No one knows for certain how currencies will move over the remainder of 2014 but we can anticipate the potential for certain pairs to be more volatile than others. Due to the tapering programme, emerging market currencies will likely be under pressure for the remainder of 2014. Not all businesses deal with emerging markets but many do transact business in South East Asia and or South America. Both are geographical regions with current economic and socio-political issues and a resulting cooling of the once vibrant economic growth potential.
The so-called BRIC countries (Brazil, Russia, India and China) and other emerging markets such as Argentina and Turkey are experiencing setbacks and are no longer the steady drivers of economic growth that they were following the 2008 financial crisis. When the US Fed initiated its first $10 bn pullback from the bond market, these were the first currencies to be hit.
At the same time as all of these geo-political events are occurring, the world is growing more closely interconnected with cross-border trade escalating, with more businesses looking overseas for growth. Levels of international trade are set to climb, with 37% of businesses surveyed seeking to conduct more global commerce than in 2013, with Western Europe, China and Asia (excluding China, India & Japan) expecting to see increased trade.
As more businesses seek to grow beyond their borders, they take on additional and often unforeseen risk.[[[PAGE]]]
In today’s global economy, most businesses are either engaged in cross-border commerce or plan to do so. As a result, complex currency liabilities quickly arise, so managing the value of future payments or receipts grows increasingly important. Once a business knows its exposure level, it will discover potential vulnerabilities and can employ basic hedges to mitigate currency risk. For most business owners, this can be a daunting task, but leading FX solutions providers offer online treasury functions that provide a consolidated, real-time, holistic overview of currency exposure.
The US clients surveyed had the lowest revenue exposed, with an average of 26% exposed. This compares to an average of 34% for companies in the UK and 37% for those in Australia. The US in general is less reliant on outside goods, whereas the UK and Australia tend to rely more on imports.
Firms with low levels of foreign currency exposure might not hedge because the downside risk does not warrant the cost, and nearly half (40%) of those polled fall into this category.
As international receipts and invoices pile up, businesses often bump up against unforeseen challenges that they didn’t face when engaging in commerce within their own borders. Respondents indicated that their most significant concerns include being exposed to currency risk (41%), finding and reaching the right suppliers/customers (26%) and having the ability to make and receive payments (11%).
When managing currency exposure, almost half (47%) of those polled aim to reduce the potential for losses, a quarter (24%) sought to mitigate downside risk while retaining some upside potential, 18% sought total certainty as to their exchange rate and 11% hope to maximise the opportunity to profit from currency movements.
Devising a hedging strategy and keeping a long-term view is of utmost importance for businesses, especially as it concerns smaller or medium-sized businesses where the owner wears many hats. Even large multinationals can have difficulty keeping tabs on rapidly fluctuating currencies; in recent quarters large blue-chip companies like Coca-Cola have had their bottom line shaved due to unexpected currency volatility.
Half of the survey respondents indicate that they do hedge, with the largest portion saying that they utilise a forward contract (44%). Other strategies employed are natural hedging via geography (5%), options (3%), futures (1%) and swaps (1%).
In addition to currency volatility (43%), other top challenges facing respondents seeking to mitigate risk include global economic policy uncertainty (17%), lack of currency expertise/savvy (16%), access to accurate timely market data (10%), difficulty assessing currency exposure (9%), cost of hedging (4%) and lack of automated processes/platforms (1%).
While devising a hedging strategy seems daunting, once a business knows its currency exposure, it should lock in a hedge that will provide certainty for the business, leaving the casino mentality to traders and speculators.
This advice would seem to resonate with survey respondents, who indicated that competitive currency rates (75%), customer service (63%) and currency expertise (47%) were the most important factors when considering a payment solutions provider.
The forward contract is the most commonly utilised hedging strategy among businesses and has seen an uptick of approximately 25% in usage since 2008. It’s a basic and sensible strategy for businesses with regular payments and receipts, offering a hedge against volatility while allowing them to construct fixed and reliable cash-flow forecasts. At its core, a forward contract is a contract to buy or sell an asset (in this case a currency) at a specified price at a future date. You’re locking in a rate of exchange for a future payment, for example. For a majority of business owners, this is as complex an instrument as you’ll need.
A forward-extra (sometimes known as a risk-reversal or forward-plus) would offer a protective rate guaranteeing you a price if the base currency weakens. If the market moves favourably, you may also have the opportunity to exploit that shift and buy at a cheaper rate. Again the potential upside is capped but the gain is in guaranteeing a ‘worst-case’ price, while retaining the opportunity for a better rate down the road.
In short, know your currency exposure, lock in a hedge that will provide certainty for your business and don’t fret about short-term ebbs and flows in the currency markets –but focus instead on growing your business.
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