By Alex Edwards, head of the corporate desk at UKForex, part of the OzForex group
International trade may be lucrative, but it also carries significant challenges. One of the biggest of these is currency risk, often inadequately handled by small businesses.
You only need to glance across the channel for events affecting currency risk. The real possibility of Greece pulling out of the eurozone, the negotiations that its new government is having with creditors, area-wide deflation and a huge quantitative easing programme in place have seen GBP/EUR trade to seven year highs in recent weeks. This increase in volatility is one reason why it’s important to protect your bottom line with a robust foreign exchange (FX) strategy. Here are some tips on how best to address your FX strategy.
What is the risk?
Over the past few months, the foreign exchange market has become increasingly volatile. It’s this volatility that poses the biggest risk to UK importers and exporters. The big swings that we’ve witnessed in exchange rates have meant it’s become increasingly difficult for businesses to set budgets or forecasts.
Moreover, an adverse movement in exchange rates can quite easily wipe away a company’s bottom line. A fall in the value of the pound will make imports into the country more expensive. If you’re an exporter with a foreign currency price list, a rise in the value of the pound can and will squeeze your profits.
So, what steps can small businesses take to reduce their currency risk?
Practical steps to building an FX strategy
Forward contracts
A forward contract is a hedging tool that allows you to lock in your rate now and deliver your funds at some point in the future. It provides protection against the value of the currency moving against you
down the line.
You don’t need to hedge all of your currency exposure. This way you can take advantage of any upside in the value of the currency that you’re holding should it appreciate against the currency you need to convert it to. This can be done by agreeing a spot contract.
Depending on your risk profile, you can adopt a portfolio approach by using a combination of spot and forward exchange contracts to balance your foreign exchange risk.
Renegotiate prices with your suppliers
It might not be easy but, should the value of the currency that you hold fall significantly, there may be some room for price negotiation with your supplier. This route will depend a lot on your industry, as well as your bargaining strength with your trading partner.
Make supplier payments in other currencies
Some currencies are more volatile than others. One recent example is the Swiss franc, which strengthened by more than 40% in less than an hour following the Swiss National Bank’s decision to remove the EUR/CHF cap. If you’re a company importing from Switzerland, it’s worth asking your supplier if they can accept payments in EUR or USD, two currencies that are more stable.
If you’re an exporter, consider re-adjusting your price list
Simply put, increase your prices. To the extreme you may want to consider pricing your goods in pounds, thereby passing on the foreign exchange risk to your customers. Of course, this will be hugely dependent on the type of product you’re selling overseas. You’ll also need to bear in mind that any rise in the value of the pound will make your products more expensive in foreign markets.
Shop around for better rates
A bank will typically quote you rates between 3-5% different from the
interbank exchange rate. Try getting a few quotes from established, FCA regulated deliverable foreign exchange companies. Just be careful, as some companies may entice you in with super competitive rates, but once you’ve done a few transactions, push out your pricing margins. Ask questions around pricing transparency and rate consistency before you do sign up, as continually shopping around for better exchange rates is a huge time-sink.
Developing a solid FX strategy is invaluable for international trade. Protecting both your profits and your global reputation, it is an asset to any business with dealings overseas.
