Written by Jonathan Pryor, head of FX Dealing, Investec Corporate Treasury
17th December 2013
With the right currency management solutions companies should be able to maximise the returns from international market opportunities.
Last week, over 100 UK business leaders headed to China as part of the Prime Minister’s trade delegation, many of whom were no doubt eagerly seeking to build new export or import deals with Chinese companies. David Cameron was also clear in his ambition to secure economic ties with China, and was even accused of behaving more like a businessman than a politician, but rebuffed criticism by announcing the visit had delivered over £6bn worth of deals.
The UK Government has also said that increasing exports is at the heart of its economic recovery plans, with the UKTI setting a target to have 100,000 more companies exporting by 2020, with the value of UK exports doubling to £1 trillion in the same period.
This is all good news, and if economic growth continues along the path that the Office for Budget Responsibility forecast last week (2.4% GDP growth in 2014), next year will be good for businesses. However, growing by targeting international markets and boosting export and import volumes needs to be approached with a degree of caution.
In my experience, there is often a lack of understanding about the extent of currency risk faced by companies. Even seemingly mundane tasks such as setting prices and managing payment in foreign currencies can be fraught with challenges for inexperienced importers and exporters.
However, there are also opportunities and with the right strategy, foreign currency transactions can be far more than an administrative burden – they can act as a profit accelerator, with currency hedging and repatriation used to increase the value of revenues generated overseas, when the funds are converted back into Sterling.
One of the biggest problems that UK exporters face is the dilemma of whether to hedge their future order book to negate the potential impact of currency fluctuations. Whilst the UK might be reasonably optimistic at the moment about the trajectory of its recovery, global markets are still volatile and businesses should be prepared for dealing with large swings in their order books.
Some companies may have more visibility on their foreign order book, and in these circumstances forward hedging is a viable route to tackling currency risk. However, for businesses that have found success exporting their product abroad and do not have the confidence to hedge, then the uncertainty of agreeing prices is a real headache, particularly when it’s combined with the recent unforeseen appreciation in the pound against most other major currencies.
There’s always the chance that the currency could move in your favour but it’s a risk that businesses would rather avoid as potential currency losses could easily wipe out the advantage of selling a product around the world.
We are speaking to an increasing number of financial directors who are looking to take a more proactive and sophisticated approach to managing currency risk. Most are looking to achieve this by hedging expected overseas revenue rather than trying to second guess the unpredictable foreign exchange markets and leaving it to the exchange rate on the day. A portfolio approach involving spot purchases, forward obligations and option products is fast becoming the most popular way of managing currency risk.
The combination of these tools helps spread risk when buying currency for international transactions but is also valuable for firms repatriating revenues earned overseas, helping achieve an attractive average rate for converting currency back into GBP.
Hedging also allows some flexibility in the amount that has to be converted. Using a portfolio approach will mean that if certain contracts from abroad do not materialise or payment is late, then it’s easier to manage the shortfall. It means businesses have the confidence to leave a small amount to discretion and may only hedge 50% of their expected receivables.
Currency is a business risk that will not disappear for any UK company with aspirations to expand overseas. However, there are solutions available to minimise the risk of currency exposure and help it become a profit accelerator by repatriating funds at beneficial rates and buying frequently used overseas currency when GDP is at its strongest.
With the right currency management solutions companies should be able to maximise the returns from international market opportunities.
Source: Director of Finance Online