March 2017 saw Brexit enter a new phase, with Article 50 triggered; in April an early General Election was announced.
Both events were acknowledged by financial markets. In currency terms, sterling climbed against both the dollar and the euro immediately following delivery of the Article 50 letter and climbed again following the General Election announcement, to its highest level against the dollar since October 2016 and against the euro since December 2016. Commentators quoted Deutsche Bank, one of the world’s biggest sterling bears, as describing the early election as “a game-changer” for the pound.
Great news for imports, and for Spring holiday makers heading overseas. However, for Scottish businesses reliant on exports, engaged in contracts tied to currency other than sterling or operating abroad, the short-term effect of further political discourse is currency volatility at best, and currency risk at worst. Forecasts must be kept under careful review, as must spending.
For businesses concerned about currency risk, however, it may be worth considering forward contracts. A form of derivative, a forward contract allows a business (or individual) to fix its rate of exchange for a fixed period, which may be up to 3 years, based on the interbank exchange rate at the time of booking.
Businesses with either significant interests or regular trading in a currency other than sterling are likely to fix their currency for the following reasons:
1. It provides the business with greater certainty as to future pricing and cashflows;
2. It allows the business to prepare more robust forecasts and budgets;
3. It mitigates the risk of significant swings in foreign currency exchange rates and, to an extent, the requirement to pay close attention to daily rates when assessing best timing for payments; and
4. It demonstrates appropriate risk management to the market – i.e. funders, customers and other stakeholders.
As ever the case when seeking to mitigate risk based on external factors, the counter is the risk that the financial markets move against the fix – i.e. rates falling such that it would have been cheaper for the business to buy at the spot / daily rate.
As a financial product, existing facility documentation should be reviewed in advance of fixing (and discussions around that) to ensure that any new forward contract doesn’t interfere with or jeopardise the terms of the business’s existing finance. Existing funder(s) should be fully engaged with and made aware of discussions around the appeal of any derivative product, particularly if that funder is not the party likely to provide it.
Equally and perhaps more pertinently, as a financial product there will generally be a cost associated with entering into any forward contract, which will require to be assessed as against the risk of further currency movement and the term of the proposed fix.
Taking the right advice
A situation where one size does not fit all, each business dealing in a currency or currencies other than sterling requires to consider the appropriate priorities for that business. Most major (and mid-sized) lenders offer multiple forms of foreign exchange risk management and will be happy to discuss particular products with their customers – new and existing – and accountants or other financial advisers should also be consulted when considering the relative pros and cons. In the meantime, businesses may wish to keep a close eye on the political situation – at home and abroad – and its effect on their top and bottom lines.