Keep Forex to the Fore
Last year in the immediate aftermath of Brexit, we wrote an article to get people focused on the basics in this space.
This article covers both what has happened (and not happened) in the subsequent months and also highlights some new areas of focus. The content of the previous article remains relevant today and should be re-read in conjunction with this article.
1. EUR/GBP trends
Not surprisingly the foreign exchange rate has been quite volatile. In fact, if one considers the trends since July of last year there has been a move of 3.5p-4.0p either upwards or downwards on 10 occasions since (to the end of March). The peak to trough move in the rate in calendar year 2016 was 28%. And, of course, for those with their cost base in EUR, a reduction in GBP sales of €100,000 is a reduction in profits of €100,000. Outlook for 2016? Geopolitical trends are making currency forecasting even more difficult. It would be expected that the peak to trough range for EUR/GBP in 2017 will be lower, maybe 15%, which is substantially better than the 2016 equivalent but worse than the average since 2000. Next significant risk for EUR is the French election. A Le Pen win would weaken EUR and while at this point in time it looks unlikely, one never knows what can be dug up in political campaigns, so the first lesson would be to take few chances on exposures that mature (or could arise) in May! Interest rate moves will also begin to influence the currency. EUR longer-term interest rates have increased over the past few months while market expectations on the possibility of a UK rate rise sooner than previously thought have risen, not helped by the inevitable rise in UK inflation. Higher interest rates tend to support a currency: so where will rates rise first?
2. Attitude to currency hedging
Have I seen a marked increase in a structured approach to currency hedging? The short answer is “No”. What I saw was a lot of panic when the rate hit EUR/GBP 0.9000 but as soon as it eased back to EUR/GBP 0.8500, not only did the panic ease, the urgency to manage the risk quickly disappeared. Why? Sounds like EUR/GBP 0.8500 is a rate which a lot of exporters can live with. If that is the case, then structure your hedging around it – don’t leave it to chance. The last 12 months should clearly highlight that those with a common sense structured approach to foreign exchange (“FX”) hedging have a competitive advantage. An advantage which they can achieve without leaving their desk and which they cannot be stopped achieving by their competitors. So why ignore it? If you had a product that you sell to your customers at €10 thereby making a 10% net margin, would you sign up to a contract that states the price paid will be what the customer wants to pay on the day and that price could be anywhere between €8.50 and €11? Or would you let employees decide whether to be paid €10/hr or €15/hr when manufacturing a product? The answer to both is no, but those examples give the same outcome as not hedging FX exposures but leaving it to the spot market on the day. This element of business is a controllable.
Most companies are at the low (and some at the very low) end of currency hedging knowledge. Again, this is controllable. Investing time in upskilling in this space is exactly that – an investment. What you learn will benefit your business for years. So, focus on it. And watch “conventional” thinking. One company told me that they were invoicing in EUR to UK customers so they had no exposure. However, when questioned, they admitted that the customer was looking for a price decrease in EUR (to counteract the fall in GBP). And as a price taker this was inevitable. They also admitted that getting a price increase if GBP strengthened would prove very difficult. So not only is that not really a hedge, it could be viewed as a ratchet. And it is not (for the most part) a controllable!
4. Strategic issues emerging
While it is going to be difficult to anticipate all implications, the need to react quickly is inevitable. So, a few suggestions of matters that require attention in the coming months as the negotiations are started:
- All new finance applications will require a Brexit evaluation. So even if you don’t want to formally address it, your banks will require it
- Worst case scenario is WTO tariffs. Ascertain NOW where your products sit and what tariffs might/would apply under those rules
- Assess how far GBP would have to strengthen to counteract the cost of the tariffs (assuming that you are a price taker)
- If your main competitors are based outside the UK then they face the same situation as you. If not, UK competition must be your focus. Undertake a UK competitive SWOT analysis. This may give some indication on your ability (or that of your market) to bear some of the tariff costs as price increases
- Understand the dynamic between price and demand for your product – you may be able to force an element of price increase on customers but if it has an adverse impact on volumes, then you need to watch your fixed cost base and try to drive down the break-even volume
- Understand the dynamic between rising interest rates and demand for your product. The UK could find itself in a situation where economic growth is poor but interest rates are increased to curb inflation, thereby decreasing disposable incomes. This is especially true for people with mortgages as UK interest rates have been flat since March 2009. Is your customer demographic exposed to rising interest rates more than other segments of the population? Could you target a demographic that is less susceptible to such trends?
- The above may require more GBP costs/UK presence, but it could also be an opportunity (see below).
5. Issues for the Island of Ireland
- Cluster approach to informing exporters – they will all face similar challenges
- Emphasis on education – better informed exporters will trade better
- Cluster approach to provision of UK support – shared logistics, warehouses, even admin and support services?
- The common travel area may be very important. Instead of the Celtic Tiger era where Irish people were buying UK property at rapid rates, the ability to travel to the UK and own UK operations may become crucial (and a competitive advantage) for some sectors. Looking for new markets is now probably inevitable but the UK will remain a core market for many (and may become more important if non-UK competitors are squeezed out).
Yes, there are plenty of challenges ahead, but there are also plenty of opportunities. Never waste a good crisis!