Antonio Rami, Co-Founder of Kantox
Political uncertainty and market volatility have become the new normal for businesses in recent months. Since the vote for Brexit, the unfolding negotiations have seen the currency markets enter a roller-coaster ride – none more so than sterling. We even saw the pound drop to a 30 year low as it reacted to Theresa May’s announcement that the UK would begin formal Brexit negotiations by the end of March 2017.
After a period of seemingly little change to the business landscape, we’re now beginning to see businesses feel the real effects of this volatility. Tescowas forced to temporarily remove Unilever products from their stores in reaction to the supplier hiking prices to compensate for the sharp drop in the pound’s value a few week ago. Shares in EasyJet also crashed following reports that the slump in the pound has cost it approximately £90 million, and more recently, computer manufacturer Apple hiked the prices of its new laptops by up to a 20%.
Strong strategies
With currency volatility reaching severe levels, businesses must ensure that rational risk management strategies are in place so that they are not caught out. The first step towards an effective risk management plan is integration: This cannot be a concern exclusively for the treasury department, as has traditionally been the case; these plans now need to be adopted by the whole organisation.
If businesses were to implement old-fashioned strategies, whereby an exchange rate was defined and an approximate volume of sales was calculated, they may survive through periods of relative stability. However, these outdated techniques won’t cut it in today’s economic climate, which is far from stable. If the market moves at an unanticipated rate, which it has done so for many months now, these strategies won’t allow the business to act quickly enough to ensure that profits aren’t affected.
This is why efficient FX strategies need to take into account the specific currency needs of the company and for that matter it is crucial that the finance and business teams work together in order to define an FX policy based on target exchange rates and risk tolerance levels, established through empirical reasoning and according to real numbers that exclude optimism.
Furthermore, the management at macro level has to be combined with micro-management actions down the line. These actions should observe the different currency risk cycles in each business line and apply the alternative hedging approaches when needed. To keep the company’s profit margins steady, the FX strategy needs to be able to flex to all situations.
A clear policy, with the right tools to monitor FX exposure in real time, paired with a certain level of automation, will be the recipe for success for minimising the impact of unexpected currency swings.
Dynamic hedging
Some sectors are understandably more prone to the effects of currency volatility, take for example the travel sector. Businesses in this sector should look to implement a dynamic hedging strategy that takes into account a number of different strategies in parallel that can be automated to manage currency risk and protect profitability.
An effective dynamic hedging strategy will need to have identified the businesses FX exposure from inception. It will then need to define business rules to manage exposure, according to the FX policy. This kind of strategy will also need a tool to monitor FX in real-time (monitoring FX markets manually would be a full time job in itself!), and lastly, it needs the ability to automate trade execution which will enable the business to address volatility in real-time, without wasting time on manual processes.
By deploying a dynamic hedging strategy that encompasses all of these elements, one of our larger clients in the travel sector managed to reduce the impact of FX volatility on its profitability to less than 1% in 2015, resulting in a net saving of over 500,000 USD simply on exchange rate margin in the past year.
Centralising currency risk management
Businesses that deal with extensive volumes of payments in multiple currencies, simply cannot waste time managing each currency individually. This would not only be a drain on the finance team’s time and resource, but by taking each currency separately as opposed to looking at the whole payment flow, payments to suppliers and sales in different currencies could be dramatically affected. Creating a central point whereby the business manages payments as a whole, is a sure-fire way to enhance efficiency. With the one-platform approach, businesses will ultimately minimise the risk of losing money down to poor exchange rate management whilst also increasing liquidity by boosting cash flow.
We are continually seeing how the volatility of the pound in particular is affecting the day-to-day management of enterprises, but these businesses should not focus on monitoring the pound alone. It is experiencing a moment in the spotlight, but other currencies could just as equally be affected by unexpected global events in the coming months. Maintaining a global view of the businesses risk exposure and relying on automation to deploy strategies in real-time is the key to success for companies in these uncertain times.