Beware long-term currency volatility

Volatility in the currency markets means companies would be well served to review their international payments policies

Currency volatility has dominated finance directors’ thoughts since the beginning of the year as global events impacted hedging strategies and hit the bottom line of international businesses.

The strength of sterling and the US dollar against the euro dominated meetings in the first quarter of the year, but attention has since shifted away from the out-and-out strength of these currencies to the prospect of long-term volatility.

David Rodriguez, quantitative strategist at DailyFX, says: “We saw the euro nearly freefall versus the US dollar and other major counterparts as the European Central Bank cut interest rates into negative territory and began aggressive quantitative easing policies.”

A poll of 96 chief financial officers by consultancy Deloitte at the end of March found many of those not previously concerned with currency risk are now looking at hedging options to offset potential exposure.

FX Statistics

The research concluded that companies with global distribution are employing the most extensive hedging approaches, focused on strategies which match income with expenses in local markets. Companies with a narrower distribution line, however, were more likely to focus on debt management and individual financial instruments to offset their risks.

Jerome Albus, senior vice president, payments and messaging at SunGard, says forecasting for businesses can be extremely challenging in the current climate, but there are steps firms can take to make hedging and forecasting easier.

He explains: “Forecasting can be more challenging when you are managing with ten, twenty or even thirty foreign exchange pairs. When it comes to payments there is also an added complexity due to the multitude of systems, subsidiary locations and approvers. Gaining control over all of these payment flows is usually the obstacle. Once done, companies can be more proactive with their hedging programmes.”

Mr Albus recommends that businesses set aside time to obtain a true view of payment flows and cash collections. “Understand the trade receivables portfolio, the risk inherent in the portfolio and then, of course, your cash outflows,” he says. “Without a strong forecasting ability you cannot appropriately manage the risk.”

You could be forgiven for assuming this is just common sense, however, the Deloitte report found that around a third of global businesses are not actively managing their currency risks. And for those companies that are actively managing their currency exposure, few are reviewing their hedging strategies on a regular basis.

Jessica James, managing director and head of the foreign exchange (FX) quantitative solutions group at Commerzbank, says all companies should start by looking at historical trends and thinking about their vulnerabilities.

“One thing which is so often forgotten, but so important, is to look at history. If a company is wondering how to hedge FX risk, it will have a number of different contracts it can use, ranging from very simple forward contracts which lock in a future rate to complex contracts with a lot of conditions and contingent pay-offs,” she says.

As straightforward as it sounds, FX volatility is the number-one challenge

“I would say that to minimise and manage FX risk, a company should look back through the historical performance of different hedge contracts for the currency pairs they are exposed to, and they may well be very surprised.”

The use of real-time and post-trade analytics systems can vastly improve the efficiency of international payments by understanding corporate exposure at any one time. However, it can also improve the bottom line.

Delays in international payments can leave companies open to sliding currency markets, which can wipe out profit margins and leave once-profitable product lines loss-making.

Ranko Berich, head of market analysis at Monex Europe, explains: “As straightforward as it sounds, FX volatility is the number-one challenge.

“Some businesses can remove risk altogether and hedge their exposure to risk, while others leave a percentage unhedged. What is essential for all companies is acknowledging and evaluating its exposure.”

SunGard’s Mr Albus says there is a silver bullet to resolving many problems – reducing complexity. “Complexity creates increased costs, and risk of error and fraud. It is essential to gain control over the payment flows and that is why so many companies are now looking to bring in a payment factory approach,” he says.

Experts believe volatility is likely to be with us for the long haul, so those companies that haven’t yet acted may be well advised to do so now.

John Booth, chief executive of Midpoint Holdings, warns: “The increasing volatility of cross-currency rates is probably the greatest challenge for larger corporates as swings are getting larger and more violent due to the enormous leverage in the global financial system.”

His views are echoed by other industry experts. Martin Arnold, research analyst at ETF Securities, adds: “We expect that the European Central Bank’s activities will continue to keep the euro under pressure. While a weaker euro has been a boon for companies that operate in foreign markets, businesses which import goods will be worse off because margins will be squeezed.”

SWISS GNOMES’ SURPRISE MOVE

SWISS GNOMES’ SURPRISE MOVE

One of the major foreign exchange events of the past year was the Swiss National Bank’s decision to end is pegging to the euro.

Many businesses that had not hedged external revenues found a sharp decline in revenue bases in local terms and it encouraged many to review their internal practices.

John Booth, chief executive officer of Midpoint Holdings, explains: “The Swiss National Bank’s decision to remove the cap clearly had a huge impact and dramatic adjustment to the pricing of the Swiss franc against all other currencies.

“Many margin traders were caught offside and bankrupted by the event. We saw a severe negative impact on Swiss export business and local tourism.”

Jeremy Roberts, head of UK retail sales at global asset management group BlackRock, says surprise central bank actions may no longer be occasional occurrences. Businesses seeking to review their international payments policies would do well to be mindful of this insight.

He says: “The prospect of surprise central bank actions – for example, the Swiss National Bank’s removal of the franc’s minimum exchange rate floor in January this year – introduces the potential for bouts of volatility, nervousness and unseen risk into an asset class that has traditionally been viewed as a safe haven in times of market stress.”

Martin Arnold, research analyst at ETF Securities, says the event focused the minds of international businesses. “Rising volatility in currency markets is a significant consideration for international companies which needs to be addressed with appropriate risk management processes,” he says.

Mr Arnold adds that the unpegging of the Swiss franc was one of two events which triggered reviews at global businesses. He also flags the European Central Bank’s decision to implement its quantitative easing programme as another turning point.

Also found in Currency FX Payments Risk