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09 November 2011

Navigating these stormy economic waters

In 2011 the reality is no one really knew where their currency was heading. In stormy economic waters what does a great FX hedging outcome look like and what can we learn from back then to apply to storms today.

Many exporters still confuse foreign exchange management with trying to predict where the currency is going. The reality is that no one knows where the currency is heading today, tomorrow, next week or next year. In these stormy economic waters and  volatile times it has got a whole lot harder, especially for exporters who are not just grappling with the volatility but also with a currency which against most of our trading partners is close to historical highs.

So if you can’t predict where the currency is going what can you do to better manage your exposure to the daily fluctuations in the currency, which are no doubt seriously impacting on most exporters’’ profitability.

Discipline needed to navigate stormy economic waters

There are certain disciplines that any exporting company needs to know about that is dealing in foreign exchange. For many of these companies it has the biggest impact on the profitability of the organisation. How many times have we heard that if the currency goes above 70 cents or 80 cents or 90 cents I am out of business but how many companies also know what their true position is.

The first thing you need to know is what are my exposures, what are my expected foreign denominated cashflows that I can forecast with some certainty over the next month, next year or longer if you can accurately forecast out that far. You then need to think seriously about what exchange rate am I profitable and at what level am I not making any money.

Next you need to think about how am I going to cover these future foreign exchange flows. What are the products that i can use and who is going to provide these products to me?

Forward foreign exchange contracts

Most are aware of forward foreign exchange contracts which can be used to lock in an exchange rate for a future date. If you aren’t at least using forward foreign exchange contracts then you should be. Converting the funds when they arrive in your bank account is unlikely to be a long term successful strategy (especially in the current environment) and it is also likely you aren’t getting the best exchange rate on conversion from your bank.

If you are still dealing with the local branch of your bank you should talk to your Relationship Manager about dealing directly with the banks fx dealers to ensure you are getting the best pricing possible. Remember you can negotiate both the margin the bank is charging you and the ultimate price the fx dealer is quoting. This is especially important when transacting fx contracts out into the future. If you are dealing with more than one provider then even better as this puts some competitive tension into the pricing.

You might want to also consider fx options. Options are like an insurance premium on your future fx receivables. An option gives you the right, but not the obligation, to transact at an agreed rate. Whilst often deemed to be expensive they should be a consideration as part of your overall fx management. In the current environment with the kiwi having been in an uptrend for some time forward exchange contracts has been the best strategy, however at some stage in the future the kiwi will be in a downtrend and when this is well established options would be a worthwhile consideration.

Banks are the obvious ones to sell you fx and options but there are also numerous reputable fx brokers around who provide good rates and good service. In days gone by the banks have not serviced small to medium sized businesses as well as they could but in recent times this has changed and they are generally very focused on servicing this sector much better.

Sensible parameters needed

In navigating these stormy economic waters, consideration should also be given to having some sensible parameters around how much cover is appropriate to have in place given the accuracy of your cashflows, competitive situation and other relevant factors. You may need some outside expertise to provide this and there are a number of independent advisors who will put together an appropriate treasury risk policy.

The last piece in the puzzle is being able to record, report and value your fx transactions. Most still use spreadsheets to do this but we all know the downside of using them. It is a well documented fact that most financial spreadsheets have at least one error in them and the risk of not recording a deal correctly is too big to take for most organisations. More and more Directors of companies are looking to move away from the reliance on spreadsheets where possible as the risks associated with fx are too high to take the risk of missing a deal and the potential cost.

More than just spreadsheet risk

But it isn’t just the risk of using spreadsheets it is also having access to the best possible information to make the best possible decisions. Spreadsheets will tell you where you are now but they won’t tell you where you are heading. It is always important to know what your current position is based on the cover you have in place but what about your total position based on the cover you are still to take. Are you still profitable at this level? Or what happens if the currency goes up another 10%, what does that mean for the profitability of the company? Should you lock in everything now because you can’t live with the currency moving higher?

These systems exist and they are inexpensive, especially if compared to the risk of missing a deal or not knowing what your true position is. Like any business decision, the better the information the better the outcome.

For most exporters fluctuations in the currency is a daily topic of conversation and many are grappling with the historical highs in the stormy economic waters we are currently facing. There is no crystal ball to tell you where the rates are going from here but there are some common sense measures that in the medium to longer term can be put in place to ensure the ongoing viability of your business.

If you would like to learn more about better managing your FX hedging exposure – take a look at our FX Exposure Tool.

 

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