The unknown and the unpredictable are two of the most feared words in business. There’s nothing that causes markets to rock more than uncertainty and following UK voters’ majority decision on June 23 for the country to leave the European Union (EU), the future is far from set in stone.
The pound (GBP) dropped to a near 30-year low in early October after markets reacted to prime minister Theresa May’s announcement that the UK would begin formal Brexit negotiations by the end of March.
Already we’re starting to see tangible effects of this volatility. Most recently, the UK’s biggest supermarket chain, Tesco announced that it was temporarily removing a number of Unilever brands from stores, after the supplier hiked prices in the UK to compensate for the sharp drop in the pound’s value.
This issue may have since been resolved, but the impact of the pound’s volatility goes beyond a shortage of Pot Noodle at local supermarkets. Almost every industry stands to be affected in one shape or form by Brexit – none more so than the travel industry.
Shares in budget airline easyJet lost early 7% on October 5, after the company reported that the slump in the pound since Britain voted to the leave the EU would cost it approximately £90m over the next year, against an earlier estimate of £35m.
With UK chancellor Philip Hammond indicating that this is just the beginning of the volatility that is to come, how can corporations in the travel industry avoid the financial pain suffered by easyJet and others?
Certain strategies for uncertain times
In times of turbulence, rational risk management techniques are crucial to ensure that companies are not caught out. Those strategies should be adopted by the whole organisation – and not just the treasury department.
Old- fashioned hedging strategies consisting of defining an exchange rate and calculating an approximate volume of sales might do the trick in periods of relative stability, but they can catch companies out during times of sharp volatility. If the market moves beyond expectations – as it tends to do more often than not – the company does not have the means to react.
An efficient foreign exchange (FX) strategy should be defined taking into account the specific currency needs of the company; and that means not only working at a general level, but also at micro management levels.
On the general level, it is crucial that the finance and business teams work together in order to figure out the most appropriate FX policy in terms of target exchange rates and risk tolerance, based on empirical rather than emotional reasons. That strategy should be based on real numbers and exclude optimism.
However, there will be different currency risk cycles and different business lines demanding alternative hedging approaches. The company needs to be able to adapt to all these situations, to maintain steady profit margins. Only a clear FX strategy, coupled with the appropriate tools to monitor FX exposure in real time, will allow enterprises to minimise the impact of unexpected events like Brexit.
Having total control of the exposure and the flexibility to act in a timely manner demands a degree of automation; manual and discretionary hedging techniques simply won’t cut it. Monitoring FX markets manually would be a full time job in itself.
Dynamic hedging against exchange rate volatility
The sheer complexity of currency activities in the travel sector calls for a blend of many strategies, deployed to safeguard profitability. Implementing a dynamic hedging strategy that encompasses a number of strategies in parallel helps to efficiently automate the management of currency risk. There are four simple steps that any dynamic hedging strategy should include:
- Identify your business’ FX exposure from inception.
- Define business rules to manage exposure, according to your company’s FX policy.
- Use a tool to monitor FX risk in real-time.
- Automate trade execution to enable you to answer to volatility in real-time, without wasting time on numerous manual processes.
One of our company’s larger clients within the travel industry successfully deployed a dynamic hedging strategy to reduce the impact of FX volatility on its profitability to less than 1% in 2015. This has resulted in a net saving of over US$500,000 simply on exchange rate margin in the past year.
Centralisation of multi-currency payments
When dealing with a huge volume of payments in multiple currencies, enterprises in the travel industry can’t afford to spend time managing each currency individually. As well as being a drain on the finance team’s time and resources, taking each currency in silo – rather than effectively managing the whole payment flow – can affect payments to suppliers and sales in different currencies.
Creating a central point through which the company manages payments is crucial to boosting efficiency and reducing the burden of bureaucratic tasks. By managing the exposure across each of these currencies from one platform, corporations can avoid losing money on account of poor exchange rate management and increase liquidity, by boosting cash flow.
Brexit discussions and the subsequent volatility of the pound is already having a measurable effect on both UK and European companies in the travel industry, but these enterprises can’t limit their strategies to monitoring the pound alone.
Currency volatility can come from any corner of the globe, even when you least expect it, which is why the finance team needs to maintain a global view of their risk exposure, relying on automation to ensure strategies can be implemented in real-time, before volatility starts to hit profit margins.
Whether responding to questions from other stakeholders or seeking to monitor the effectiveness of their risk management processes, treasurers and FX managers in growing companies with expanding foreign currency exposures need solid analytics to support their decision making.
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