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Financial management and Brexit

by | Feb 25, 2019 | Brexit, Financial Planning and Currency Management

Director of Artemis Consulting Moira Creedon is working with Enterprise Ireland advising companies on financial management and Brexit.

 

“Irish businesses need to assess how Brexit could impact their business and how bad that impact might be if there is no free trade agreement between the EU and the UK at the end of the transition period. That conversation usually triggers immediate action though responses range widely depending on the degree of exposure. For some companies this conversation kickstarts a general upgrade in financial and operational management to drive better profitability and reduce risk, which is always a good idea. For other companies Brexit demands root and branch strategic change”.

 

Currency fluctuations

The most obvious Brexit exposure where financial management can help is currency volatility. For a company with a cost base primarily in euro, and revenues primarily in £, negative movements in Sterling will quickly erode profit margins.  In a tight margin business this can easily trigger losses.

Use the Currency Impact Calculator to estimate the impact an adverse change in exchange rates would have on your business profitability.

 

Use a simple strategy if possible

There are several ways of addressing this. Moira advises starting, if possible, with the simplest strategy – invoicing clients in Euro. Not all UK clients will accept this, but many will be exporting to Europe and may even need to increase their percentage of euro costs, in which case they will be more than happy to oblige.

 

Is it possible to increase price to the UK market to cover the drop in sterling?

Companies are often afraid to raise this with UK clients on the assumption that they will end up uncompetitive compared to UK competitors. Whether this can work or not depends on the sector. In many sectors such as food and construction materials, your UK competition are buying the raw materials in a global market place and their costs in £ have increased.

Keep a tight eye on your sector dynamics, you may find your UK competition are also forced to increase price.

 

Natural Hedge

Natural hedging means getting the percentage of Sterling costs in line with the percentage of Sterling revenues by purchasing more in the UK, for example outsourcing manufacturing to the UK, paying UK based staff in sterling or buying materials in the UK.

Moira worked recently with a company with 90% of their revenues in the UK: “Initially, I was naturally concerned, but then realised that roughly 90% of their cost base is in UK pounds. So they are automatically, naturally hedged. If the pound crashes, their costs and revenues crash so the margin is maintained. Equally any increase in sterling will increase the cost base but will be compensated by the revenue increase”.

 

Hedging – Forwards and Options

Hedging using financial contracts is basically an insurance policy so your business will not be adversely impacted by a collapse in Sterling.

Banks and other specialist FX risk management companies offer forward contracts so you get a guaranteed exchange rate now for sterling inflows in the future. These contracts are relatively simple and cheap, so apart from the initial set up paperwork, the main downside is that if the UK £ shoots up you are locked in at the agreed rate.

This creates a market demand for ‘options’. These contracts are similar in that you agree an exchange rate in advance but very different in that if currency values move in your favour you can tear up the contract. So you can “have your cake and eat it” – you are covered against a drop in Sterling but you can still benefit if sterling shoots up. But of course there is no free lunch, these contracts are more expensive. Talk to your bank  – explain your exposures and see what they can offer.

It is important to understand that setting up good hedging cover means you have to have accurate forecasting in place so you can see what is coming in and going out by currency – so you may need to improve your financial forecasting processes.

Application processes and deposits required to set up hedging cover can be onerous. It is well worth approaching one of the Foreign Exchange risk management  services companies, for example Irish providers gaining traction in this space include AssureHedge, Fexco, Transfermate and CurrencyFair.

 

Long term competitiveness and the impact of a drop in sterling

Financial contract based hedging is only a short-term insurance policy: “If the competitiveness of your product is being eroded in the long run, hedging alone is not going to save you”.

For example Moira is working with an ROI based client near the border in the hospitality sector who is experiencing a collapse in cross border guest trade from Northern Ireland. Weaker sterling means overnight ROI hotel prices in euro seem very high so guests are staying put in Northern Ireland. No hedging contract can help in this scenario. Market diversification is critical, you need to offer a clearly differentiated offering and get out to reach your target market segment in other markets.

 

Wider financial risks

There are many other financial Brexit exposures facing Irish companies, from tariff imposition, cashflow impacts from border VAT, border delays and the need to stockpile, regulatory impacts facilitating cheaper competition in UK, sourcing exposures and the sheer cost of the paperwork required to get goods through customs. Dealing with these may often require a full rethink on strategy, for example opening new markets outside of the UK, transferring manufacturing facilities to or from the UK.

Moira advises that no matter what changes a company makes in response to Brexit it is critical that it improves its overall financial management for example to get better visibility on which products are delivering profits. Businesses should also forecast the full financial impact of their chosen Brexit strategy to make sure it adds up and that support is available from all stakeholders.

 

Enterprise Ireland support

Enterprise Ireland has developed a range of supports to assist companies in their preparations for Brexit.

Before meeting with a company, Enterprise Ireland experts will request information in advance to make the engagement more worthwhile and to have a better idea of what to discuss with the business. Moira says: “We ask for information in advance and this gives us a pretty clear handle on to what extent the company’s revenue is exposed to the UK”.

 

 

 

Brexit and managing currency risk

by | Oct 18, 2018 | Brexit, Financial Planning and Currency Management

Sterling and euro volatility remains a key concern and challenge for Irish businesses

 

Enterprise Ireland is supporting companies to better understand the financial implications of currency fluctuations on their business and take the necessary actions to mitigate against this risk. The following questions cover the key issues related to the management of currency risk and are addressed by John Finn of Treasury Solutions.

 

I’m an Irish company exporting to the UK. How can I analyse the impact of movements in sterling/euro on my business?

For Irish companies exporting to the UK, the Enterprise Ireland Currency Impact Calculator can help you understand the effect of movements in the sterling/euro exchange rate on your business. This online tool is freely available and demonstrates what an adverse change in exchange rates would have on your business profitability.

 

Will my bank permit me to hedge my foreign currency exposures?

For an exporter to hedge its currency risk, in the first instance, it must first have a foreign exchange line of credit from the bank. This must be formally sought in advance prior to its use and, from the bank’s perspective, it is the equivalent of making a loan application i.e. it requires credit approval.

 

What instruments will the bank permit me to use to manage foreign currency risk?

For the most part, this is restricted to either spot or forward transactions. The former implies selling sterling at the current market rate.

As a general rule, spot deals settle in two days’ time ie agree a rate on Monday with funds transferring on Wednesday. In the case of forward foreign exchange contracts, a rate can be agreed today to apply to receipts on a future date.

The advantage of this instrument is that an exporter can bring certainty to the amount of euro that it will receive in return for a specified amount of sterling at this stated future date.

The primary disadvantage is that there is no opportunity to share in any upside in any currency movement.

In order to achieve that objective, it is possible to purchase an instrument known as a foreign exchange option. However caution is urged; it is an extremely useful instrument to utilise in managing foreign exchange risk, but it needs to be constructed appropriately. In essence, it is an insurance product for which the purchaser pays a premium and which protects it against a worst possible (defined) outcome whilst permitting full participation in the upside should it arise.

Some banks sell a combination of an option and forward contract called a participating forward. This allows participation in a fixed percentage of the upside. However it does have a cost. Again, these should not be purchased without full knowledge and understanding of what is involved.

 

How far forward can I hedge?

Most banks will have a maximum time period for which they will sell forward contracts to their customers. This needs to be ascertained now. In general, most banks will not provide forward contracts for periods beyond 12 months.

 

What terms and conditions apply?

In some cases, the banks may require security to be provided in the form of charges over assets or guarantees. If the exporter is already a borrower, it is probable that the bank would simply extend any security that it already had over the foreign exchange line. It may also monitor the extent to which the currency contracts are showing a “profit” or “loss” at a point in time and either limit this or seek some collateral, which may include cash, if the loss – although only theoretical – extends beyond the defined amount.

Finally, some banks may require the completion of what is known as an ISDA agreement. This is quite a complex document to complete for the first time, and proper advice should be taken in its construction and prior to signing it.

One final point to note in hedging foreign currency risk is that there are non-bank providers of such services who tend to be less prescriptive in their dealings. However, many borrowing agreements now specify that the borrower may only conduct foreign currency transactions with the lender.

 

What are the wider financial implications associated with currency risk?

The obvious effect of weakening sterling is adverse consequences for both profitability and cash flow. Immediate actions that could be taken include:

  • Calculation of the exchange rate at which UK sales are no longer profitable
  • Rerunning financial forecasts at current exchange rates and assessing the projected outcomes
  • Where financial covenants are part of your borrowing agreement, ensure that adverse foreign exchange moves do not materially and negatively impact on compliance with them

Please note that where companies with material amounts of UK exports intend to refinance their banking facilities in the coming months, a significant amount of sensitivity analysis will be required in any financial projections provided to banks. I would strongly urge paying close attention to the terms and conditions attaching to any new borrowing agreements.