By Seth Phillips, CEO and founder of the automated hedging platform Bound
To borrow the words of poet and civil rights activist Maya Angelou: “Hope for the best, prepare for the worst, and be unsurprised by anything in between.”
For businesses trading with partners in other countries, the constantly shifting sands of currency exchange rates have always thrown up plenty of uncertainty.
But events of the past few years, from the Euro crisis through Brexit and Covid-19, and now war in Ukraine, have seemingly made extreme exchange rate volatility the norm rather than the exception.
Let’s be clear, exchange rates fluctuate even in the most benign of times. But successive waves of supposedly “once-in-a-generation” events, from Britain’s tortured departure from the EU to the global pandemic, have created huge uncertainty that has put many businesses who trade overseas at the mercy of yo-yoing exchange rates.
Earlier this year the war in Ukraine saw not just the collapse of the Russian Rouble, but a fortnight in which the value of the Euro fell 21% against the US Dollar amid concerns about oil supply in Europe
Some dramatic currency declines can happen in a few hours, or even minutes, known as flash crashes. On 7th October 2016, one such flash crash saw the Pound drop more than 6% in two minutes against the Dollar amid market fears of a hard Brexit. And this is small change compared to the rollercoaster endured by Turkey’s embattled Lira. In 2021 as a whole, the Turkish currency lost 44% of its value against the Dollar, while in November it plunged by 15% in the space of just a few hours.
In the current economic climate, with rampant wage inflation slicing into businesses’ margins, sudden exchange rate swings can be the difference between making a profit and barely breaking even on a deal.
Impact on the business front line
This problem is particularly acute for firms that send funds overseas regularly, whether to buy goods, invest, or pay overseas staff in local currency.
Unless they specify otherwise, each purchase of foreign currency will be made at the exchange rate of the day, meaning their money will stretch less far any time their home currency falls in value.
Yet businesses have a powerful tool that can shield their bottom line from this uncertainty – currency hedging.
For years, hedging was shrouded in mystery, jargon and high, opaque costs, ensuring it remained the preserve of blue chips with the specialist expertise and budget to use it effectively. But now intelligent digital platforms like Bound have put it within reach of any small or medium-sized business that wants to protect themselves quickly and easily from exchange rate risk.
In reality hedging isn’t one tool, but several, which work together to limit the business’s risk.
Main hedging strategies
Forward Contracts: Taking out one of these allows you to lock into a specific – favourable – exchange rate for some transaction in the future, rather than just exchanging at the rate of the day.
Such contracts can be fixed for up to two years and, crucially, offer you protection if the exchange rate weakens between the moment the contract is signed and the day the money is required.
Limit Orders: This is where you set a target exchange rate and, when the market hits it, your trade will be triggered automatically. These are particularly useful if you have upcoming payments with a relaxed deadline, and therefore have the chance to try for a better exchange rate than what’s available at the time.
Stop Loss Orders. This is where you set a minimum exchange rate, at which point your trade will be triggered automatically if the market falls to your chosen rate. Stop Loss Orders are often used where there is a high risk of adverse exchange rate movement, and they enable businesses to protect their bottom line from falling below an agreed level.
Stop Loss and Limit Orders are often used together, effectively creating a range for your desired exchange rate. If the exchange rate moves in your favour, this hybrid strategy allows you to trade at the best possible rate; and if the rate moves against you, it allows you to cut your losses before the sterling cost goes too high.
Calm amid the storms
Predicting what will happen to the value of sterling in the long-term is virtually impossible.
But if there’s agreement about one thing, it’s that the lingering fallout from Covid, potential geopolitical struggles between superpowers, high inflation and central banks’ differing attitudes to interest rates all have the potential to make volatility a constant problem.
Yet smaller and medium-sized companies need not be hostages to exchange rate fortune. All businesses that trade regularly with overseas suppliers should follow in the footsteps of the big beasts, and use hedging to bring some calm amid exchange rate storms. That way they will always be prepared, whatever the weather.
Seth Phillips is CEO and co-founder of Bound, the intelligent hedging platform which enables businesses of all sizes to protect themselves from fluctuating exchange rates.
After an early career in real estate and strategic consultancy, in 2010 Seth started Enerlyte, a company designed to improve how people interact with their utilities and to reach energy efficiency and energy conservation goals. He successfully led the company through its lifecycle from concept through to launch and ramp-up.
From Enerlyte he moved to become entrepreneur in residence at The Fintech Collective, a next-generation Venture Capital platform, built to harness the power of curated networks.
Prior to co-founding Bound, Seth worked for five years as an Executive Director and Director of Product Management at Paxos, the cryptocurrency broker that provides business-to-business infrastructure for cryptocurrency.