Brexit fears are making British businesses reluctant to hedge foreign exchange risks further out the maturity curve without more clarification around the UK’s exit terms, an industry expert argues.
The prevailing uncertainty has caused increased demand for spot FX business relative to forward FX, says Michael Gowland, global head of treasury at international payments firm EarthportFX. Taking a short-term outlook on FX risks is ultimately a threat to a company’s bottom line – as many businesses discovered following the unexpected pro-Brexit referendum a year ago.
To illustrate the point, Wolfgang Koester, chief executive officer (CEO) and co-founder of currency analytics specialist FiREapps, says that if a corporation had accurately known their total euro (EUR) and sterling (GBP) exposures six months before 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.”
That’s because in December 2015 the interest rate differential (IRD) was at 0.2% for GBP-USD and 1.25% for EUR-USD, “meaning the amount of EUR and GBP exposures (risk) far outweighed the cost to hedge (0.2% or 1.25% respectively) against those currencies (reward),” says Koester.
However, last October UK sportswear company Sports Direct International warned that losses on its currency hedges could have a, “negative impact of approximately £15m (US$19m)”, if the value of the pound does not increase throughout 2017. Exchange-rate movements caused UK budget airline EasyJet to report last month its worst first-half loss for six years as it took a £82m hit from the weaker pound.
Coping with uncertainty
For UK business going forward, the key FX issue is, “the uncertainty of the UK’s exit terms from the European Union (EU) and how these will impact the country’s ability to transact overseas into Europe and beyond,” says Gowland. Complications caused by opacity surrounding the UK’s exit terms are compounded by the fact that Brexit has put the value of the pound on something of a rollercoaster ride since the vote.
Gowland has seen clients seeking more automated technology “to minimise the need to interact with the payment at every stage of the journey. As such, solutions … utilising FX automation play an important part in allowing a treasurer’s business to grow at scale and efficiently.”
An essential mechanism for businesses when coping with currency volatility is a well-structured hedging plan, he advises. This should be combined with, “a diverse number of liquidity providers to ensure minimal operational impact on business should one of those liquidity providers cease to extend credit.”
The impact of the EU’s Markets in Financial Instruments Directive (MiFID II) is the biggest concern for banks and treasurers when it comes to regulations and restrictions in a post-Brexit Britain, according to Gowland.
Business owners demand clarity
Many business owners have expressed alarm over the uncertainty Brexit brings to the British economy. Ed Molyneux, CEO and co-founder of cloud accounting software firm FreeAgent, recently joined their ranks. “The past year has been one of the most tumultuous in recent memory, thanks in part to a divisive general election and EU referendum that have caused major upheaval to the UK’s political and economic climate,” he reports.
“Given that we are now supposed to be two years away from Brexit actually happening, I believe it is imperative that every business owner in the UK has clear, up-to-date information about how the negotiations are progressing and what the effects of leaving the EU will have on critical issues such as trade and tax.”
With the current Conservative government losing its majority in this month’s snap general election, Molyneux is hopeful that there will be a rethink over the direction of the UK’s Brexit strategy. “I believe that pursuing a softer option – rather than Theresa May’s hard Brexit plans – will be far more beneficial for the UK’s micro-businesses and the economy in general,” he adds.
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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