How to mitigate currency risk

Currency market volatility has impacted many global businesses during the pandemic, but what can finance directors do to reduce risks from future fluctuations?

UK businesses with overseas operations have been handed some harsh lessons during 2020 as the economic mire from the coronavirus pandemic manifested on company balance sheets. 

Currency market volatility and supply chain interruptions caught out hundreds of companies during the early weeks of COVID-19, highlighting the importance of comprehensively managing foreign exchange risks through a structured strategy with a chosen partner.  

In the relatively calm markets of recent years, some finance directors may have overlooked developing a company-wide foreign exchange policy. While there was a spike in volatility in 2016 after the Brexit vote, 2018 and 2019 were relatively calm.  

But in 2020, this would have proved costly. On March 20, sterling fell to its lowest level against the US dollar for 35 years, with the GBP/USD exchange rate moving from 1.3157 to 1.1494 in the space of a few days.  

Those companies that were making US-dollar payments from sterling during that period, without any forward contracts in place, would have seen a dramatic difference in the amounts paid from the same payment had it been settled on March 10, compared to March 20.  

Furthermore, if they were relying on their traditional provider of banking services, they may have been additionally hit by uncompetitive exchange rates, delays in settlement or higher charges for the service.  

“Up to 85 per cent of small and medium-sized enterprises use their banking partner for cross-border foreign exchange payment services,” says Daniel Howe, managing director, Europe, Middle East and Africa, at WorldFirst.  

“Because they have a trusted relationship, they tend to use their banking provider for multiple services, but that can sometimes mean they get the raw end of the deal.”  

If they haven’t already done so, company directors with significant overseas transactions should move quickly to help mitigate against further volatility, with predictions that markets are likely to continue their unpredictable behaviours well into 2021.  

Forward planning  

Those seeking greater visibility of their future costs may opt to use a forward contract. Forward contracts allow you to secure an exchange rate for a defined period in the future, helping with cash-flow planning and potentially mitigating currency risk.  

By embracing this approach, company directors can more easily budget for future revenues, costs from overseas transactions and book transactions ahead of time yet funding them at a later date.  

“Forwards are particularly relevant to businesses in the current market due to the volatility,” explains Howe. “They offer a degree of certainty at a time when businesses will be considering plans for the next year.  

“Companies may need to agree pricing with a supplier and, if they are buying or selling at spot, that is an unknown.”  

While forwards can be a useful tool for fiscal planning, finance directors should be aware that a lack of transparent pricing can sometimes be used to inflate providers’ profits.  

“When considering the cost of a forward contract, other variables such as the interest rate differential between two currencies can affect the price,” explains Tom Kiddle, head of commercial at WorldFirst.  

“Many customers do not have visibility of these variables and how they affect the price of the underlying contract. In many cases, the customer has little certainty of the margin they are being charged for using a risk management product.”  

By comparison, WorldFirst explicitly breaks down how it has priced its service upfront. Forward points are never used as a mechanism to charge more but are instead used to reflect interest rate differentials between two currencies. 

“Those seeking greater visibility
of their future costs may opt to
use a forward contract”

Digitalisation and global trading  

The World Trade Organization suggests the pandemic may result in increased levels of international trade longer term, which means the use of currency risk management solutions could become a popular and prudent choice for businesses.  

“The global nature of COVID-19 and its impact on ecommerce may encourage strengthened international co-operation and the further development of policies for online purchases and supply,” it concluded in a May 2020 ecommerce report. Yet, while businesses have been quick to embrace online trading, many have not considered the consequences of generating revenues in multiple jurisdictions.  

“The reality is, as soon as you move online, you are global,” says Howe. “Until now, foreign exchange may not have been a major point of consideration for some, but there are lots of businesses in the UK, trading globally for the first time, exposed to risks they may not fully understand.”  

This under appreciation of currency risks can partly be attributed to the traditional opacity of the currency exchange market.  

Most traditional providers are willing to quote you a rate for a transaction, but few are willing to offer a cost. They may make additional charges for services such as account opening or annual maintenance.  

It can also be very difficult to compare exchange rates in real time as markets move so quickly. So, if businesses call multiple providers, they won’t be comparing rates at the same point in any one day.  

Worse still, a company may receive introductory favourable terms as an incentive for them to use a provider’s service, only to see this rate deteriorate over time.  

In an attempt to navigate this complexity, WorldFirst has designed a clear fee structure, based on the annual amount transferred in any one year across 28 currencies. As a new WorldFirst customer you will be allocated a 0.5% FX fee if you open an International payments account and a 0.6% fee if you open an International collection account. Take a look at our pricing structure for more information. 

Multiple uses  

COVID-19’s effect on international business has already been profound. For the global travel and tourism market, there has been enormous disruption. Airlines have faced mass cancellations and refunds, while hotel bookings between hoteliers and travel companies have also been withdrawn.  

Finance directors operating in the travel sector have needed to handle refunds from foreign market suppliers while wanting to avoid converting this cash back into sterling and crystallising a loss.  

“The travel industry has seen a recent increase in the amount of refunds received from cancellations, particularly at the start of lockdown,” says Kiddle.  

“By being able to serve our customers with a local collection account, our customers have been able to avoid multiple exchanges, into sterling and then back into the local currency at a later date. In an industry where margins are tight, having access to a local collections solution will create an important cost-saving.”  

For companies without a bank account in each local jurisdiction in which they operate, WorldFirst offers currency accounts that can be opened in a matter of seconds.  

Unlike traditional bank processes, which require an individual to be physically present, WorldFirst’s registration service for opening a currency account allows a customer’s credentials to be verified digitally.  

“Trading abroad can often be an alien environment for some companies,” Howe concludes. “Through our World Account proposition, we offer a single platform that provides customers with local domiciled currency accounts in ten global markets.” 

Excerpt from Raconteur Business Growth & Recovery special report published in The TIMES.  

Download the full report for free.