One year after the United Kingdom European Union referendum, currency exposures are top of mind to board members, CEOs and CFOs. The plunge of the British pound to a 31-year low against the U.S. dollar took many unsuspecting corporations that did not have accurate, complete and timely data to know their GBP exposure by surprise. The unlikely occurrence sensitized many multinational corporations, as is reasonable to expect after an impactful event. They are now hyper-aware of the need to know their exposures and are actively looking to see how they can leverage technology to better prepare themselves if another such surprise occurs.
Knowing your exposures: risk vs cost/reward
Although the outcome of the French presidential election and the recent German state elections have eased the fears of many corporations concerned with the possibility of a crumbling European Union, the threat of economic volatility and currency devaluation remains. Risk vs. cost/reward regarding currency exposures and the opportunity to mitigate risk through hedging has proven to be an important business consideration.
Surprisingly, prior to Brexit, several corporations did not know their EUR and GBP exposures well enough to protect themselves from material financial impact. For example, if a corporation would have known their complete and accurate EUR and GBP exposures six months prior to the June 23, 2016 referendum and hedged them 12 months out, the resulting currency plunge would have had little to no effect on their bottom line. In December of 2015 the interest rate differential (IRD) was at 0.2 percent for GBPUSD and 1.25 percent for EURUSD – meaning the amount of EUR and GBP exposures (risk) far outweighed the cost to hedge (0.2 percent or 1.25 percent respectively) against those currencies (reward).
To protect against material currency losses, a corporation needs to attain a high enough hedge ratio to minimize impacts, and the only way to successfully do so is to have complete insight into exposures using data and analytics. In order to gain a better understanding of their risk, companies are looking for both data experts and technology that can provide them with the required data.
What to Consider When Looking for a Currency Analytics Program
Still, one year after Brexit we are seeing treasury departments increase hedge ratios and invest more in improving processes. This is not surprising as it generally takes two to four quarters after a major surprise for the board to review processes, make recommendations and take final action. The good news is that running a currency risk management program is becoming more cost effective and human resources aren’t as affected.
The challenge for many corporates is understanding what their exposures are and getting complete data out of their systems. In addition, it is often labor intensive to collect, compile and standardize the various datasets. By the time the analysis is done, the data is no longer actionable enough to base complete hedge recommendations on, and as such treasury is left unable to optimally protect the company. Incomplete and unreliable data make it very difficult to run an effective risk management program and leaves companies susceptible to currency risk and the consequent surprises. To do this, corporations should implement a program which includes the following priorities:
➢ Understand the Necessity of Accurate, Complete and Timely Data
Obtaining the data needed to make strategic decisions should not be a days-long process, something that proved problematic for many corporations looking to see how they were impacted post-Brexit. Regardless of location, time of day or the data source, it is important to have the ability to pull up-to-date analytics on currency, risk and trends instantly, helping to avoid monetary hits and unexplained FX gain/loss.
➢ Recognize the Importance of Data Security
Data security is a top priority. Ensure that the sensitive information being pulled from your ERPs is secure by using a program approved by global IT and security organizations, undergoes annual security audits and implements advanced data security standards to their data centers, processes and controls. When it comes to security, terms such as SSAE 18, ISO/IEC 27001, SSO, Encryption and 2-factor authentication are not nice-to-haves – they’re essentials.
Managing currency risk throughout the continuation of Brexit is pertinent and can be achieved with both access to and confidence in the underlying data.
Brexit moving forward: volatility vs. value
Known as the economic engine of the U.K., it remains to be seen whether London will diminish as a financial center if multinationals continue to leave for more Euro-centric cities. The major tell will be the reaction of the banks; whether they decide to move their headquarters from London will seal the fate of the city as a financial hub and affect the value of the sterling, possibly further impacting a company’s bottom line.
Brexit is not the only factor in the possible relocation of banks’ headquarters – France, Germany, the Netherlands, Switzerland and other European countries are vying for their business and changing regulations and taxes to make themselves more attractive not just to multinational corporations, but to the banks as well.
The bottom line
The surprise is out and now every day the world is watching for any signs of directional change coming from the United Kingdom and the European Union. Whether there will be a devaluation of the sterling is still unknown, but one year after Brexit, the most important thing for multinational corporations to do is to prepare for whatever comes next. The desire to be currency aware is increasingly prominent in corporations across the globe, but the only way to achieve full currency awareness is to rely on accurate data which provides insight into exposures and usable analytics which allows finance and treasury to make informed risk mitigating decisions. Having good data is having confidence in the ability to protect your company from otherwise impactful currency surprises.
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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