Your Brexit sur­vival guide

Irish Independent - Business Week - - BUSINESSWEEK - Justin Doyle

Pro­tect­ing your busi­ness from cur­rency risks: Justin Doyle,

The value of any cur­rency can and does fluc­tu­ate (ster­ling is down 14pc in the last three months) over time due to the many eco­nomic, fis­cal or political va­garies that face any econ­omy and in turn their do­mes­tic cur­rency.

The out­come of cer­tain ‘risk events’ can and some­times do have a ma­te­rial im­pact on the value of cur­ren­cies de­pen­dent on the out­come of said events.

The now im­mi­nent Brexit ref­er­en­dum is with­out doubt one of those ‘risk events’.

So how can Ir­ish com­pa­nies pro­tect them­selves in such a sce­nario?

Case study: You’re the CFO of a Mun­ster-based com­pany pro­duc­ing med­i­cal devices and have just won a UK con­tract. Great news, but the price will be fixed in ster­ling not euro, ie your cus­tomer will be pay­ing you in pounds and as an Ir­ish en­tity re­port­ing in euro you will have to ex­change for euro. This for­eign ex­change (FX) ex­po­sure should ideally be man­aged in such a way that it doesn’t erode profit mar­gins built into the sale price of the prod­uct – some­thing that could hap­pen with a ma­jor ‘risk event’ like Brexit loom­ing.

Num­bers: Your UK cus­tomer will be pay­ing £100k monthly for 12 months, a to­tal of £1.2m. Your com­pany has set you a ‘ bud­get rate’ ( breath­ing space in essence) of £ 0.81 (£1 = €1.23) for that ex­po­sure against a cur­rent mar­ket rate of £ 0.78 (£1 = €1.28). So any ster­ling that you may ex­change un­der the £ 0.81 level is ad­di­tional mar­gin/profit and al­ter­na­tively any ster­ling you may ex­change over the £ 0.81 level will eat into profit. So how can a bank like In­vestec help you hedge the risk?

Strate­gies: There are re­ally four vi­able FX hedg­ing strate­gies avail­able to you:

1: For­ward con­tracts – You can de­cide to cover your en­tire ster­ling (£1.2m) ex­po­sure with spot (on the day) and/or for­ward ( longer dated) con­tracts at the cur­rent mar­ket rate of £ 0.78. Pros: Com­fort of know­ing that your en­tire ex­po­sure is hedged at a prof­itable £ 0.78 (vs. bud­get of £ 0.81). Cons: You can’t ben­e­fit from favourable mar­ket moves, ie a lower EUR/GBP rate.

2 Vanilla Op­tions – Th­ese are sim­i­lar to in­sur­ance pre­mia. You pay an ‘up front’ charge in or­der to gain the right ( but not the obli­ga­tion) to pro­tect a cer­tain rate for a cer­tain fu­ture date. Pros: Con­fi­dence you have a worst case rate pro­tected while be­ing able to par­tic­i­pate in any favourable mar­ket moves, ie a lower EUR/GBP rate. Cons: Costs can be high and de­pen­dent on the rate, date and level of volatil­ity at the time of ex­e­cu­tion.

3 Struc­tured So­lu­tions – Sim­i­lar to vanilla op­tions, th­ese prod­ucts of­fer you pro­tec­tion at a cer­tain rate at a cer­tain fu­ture date. You can utilise that bit of ‘ breath­ing space’ (£ 0.78 - £ 0.81) you have to dis­count op­tion pre­mium and al­low you to par­tic­i­pate in some por­tion of a favourable move in your di­rec­tion in or­der to en­hance or im­prove your over­all av­er­age rate. Pros: No ‘up front’ charge/pre­mium and full pro­tec­tion at a worst case rate. Cons: The prod­uct may have a knock in/out struc­ture that could push you into ex­e­cu­tion at worst case rate.

4 Cross fin­gers and hope for the best – Not ad­vis­able. Pros: You could get lucky. Cons: If you’re un­lucky, such an ap­proach could threaten your busi­ness.

Some top tips from In­vestec: There is no best prac­tice when de­vel­op­ing an FX hedg­ing strat­egy but here are some guide­lines:

1 Know your ex­po­sure.

2 Know how it af­fects your busi­ness.

3 Re­duce your ex­po­sure as much as pos­si­ble.

4 Be aware of how your com­peti­tors man­age their ex­po­sure.

5 Be mind­ful of the al­ter­na­tive ap­proaches and try to avoid too much ex­po­sure to any one rate or any one prod­uct.

6 You are try­ing to mit­i­gate risk, not be­come a cur­rency spec­u­la­tor.

While choos­ing the op­ti­mal strat­egy is tricky at best, we can help in for­mu­lat­ing a weighted hedg­ing port­fo­lio tailored to your spe­cific needs. Justin Doyle is Se­nior Trea­sury Dealer at In­vestec, with of­fices in Dublin and Cork.

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