We often encounter a common misconception among SME importers and exporters that the FX hedging market is the domain of the “big boys”. SME importers and exporters often believe that the use of financial instruments such as FX forwards and options are for “large” foreign currency costs and/or sales receipts. However, the definition of “large” is obviously subjective; the more crucial consideration is one of materiality. If the importer or exporter has the luxury of being a price maker and can pass through the impact of foreign currency movements to the customer/supplier then there is less necessity to hedge. Many businesses are not fortunate enough to be in this situation. Rather, adverse movements in foreign exchange rates have a direct impact on margins and profits. So how much foreign currency exposure warrants hedging through derivatives and what are the administrative costs of doing so? As a rule of thumb if the company has on average >$50,000 of monthly FX exposures then there is merit in taking a more active approach to managing the risk, as opposed to passively transacting at the prevailing spot rate on the day. Of course this needs to be put into context of total revenue.
Having determined that the FX exposure warrants hedging, there are further important considerations of an FX hedging programme:
- Does the company have the knowledge base to transact and manage FX derivatives? There may be a certain level of education required before committing the company to financial obligations. There are many resources available to aid the understanding of the common financial instruments available for hedging purposes. On-line resources are plentiful. Banks and brokers are always available for training sessions, too. This is mutually beneficial. Banks and brokers make money from the FX transactions, whilst the company is put in a better position to manage and mitigate FX exposures.
- Does the company have the systems and processes to transact and manage FX derivatives? Derivatives such as FX forwards and options require recording, reporting and valuing. Until relatively recently many companies were reliant on spreadsheets and bank valuations to manage FX derivatives as systems were prohibitively expensive. With the advent of cloud based systems, SME companies have access to systems at a fraction of the cost of more traditional solutions. Systems allow better management of derivatives, give better visibility over exposures, in turn increasing confidence to enter hedging. Systems allow more time to be spent on strategic decision making.
So the hurdle to entering FX hedging is not so much one of quantum, but more about having the skill set and systems to adequately manage a portfolio of derivatives. There is a wealth of resources available to help transition a company into a hedging programme and take the volatility out of profit outcomes.
For a closer look at the fundamentals of FX hedging download our Dollars & Sense eBook.