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Global currency provider Xe can help safeguard profit margins and improve cashflow through quantifying the FX risk businesses face and implementing unique strategies to mitigate it, writes Ciaran Pennington, FX consultant at Xe.

 

2020 has been a year of volatility and adaptation. On the trade front, Covid-19 has led to significant changes in consumer demand and global supply chain dynamics and affected manufacturing output and the provision of services.

As a trusted currency provider, Xe supports companies in over 165 countries, most of which during 2020 had a turnover of between £10mn and £100mn. The majority of these companies are import or export businesses and/or multi-jurisdictional through parent and subsidiary accounts or branches, and all have a degree of business exposure to the effects of changing foreign exchange market forces.

During the first quarter of 2020 and, in particular, from February onwards, we began to see a slowdown in global supply chains, which had an effect on these businesses.

For one, the international disbursement of funds began to dramatically reduce. As the weeks of the pandemic lurched ahead, a clearer pattern of global trade emerged where we saw a remaining core of committed trade that continued, which was then bolstered by the provision of essential goods such as personal protective equipment (PPE). Industries such as insurance and some services were able to continue, comparatively somewhat unabated.

Fluctuating levels of volatility being experienced across financial markets (and currency being no different) led to swings of more than 15% in some major exchange crosses – and therefore swings of +15% in direct costs, as well as in gross profit margin.

Xe noted a surge in uptake of risk management tools, including forward contracts and market orders: one aims to mute the impacts of the volatile climate on the costs of global flows, the other seeks to improve the overall entry position of these forward contracts. In both cases, these were significant, and the results were successful given that even where FX rates are unknown and may rise and fall, this particular currency move was initially one-sided (with whipsaws coming later) and the certainty of costs enabled a far more effective view for businesses to forecast and allocate resources with 100% accuracy.

The following example illustrates how this worked for companies with exposure to currency:

Company A is a services firm with a presence in the UK and the US. The business captures around 60% of its revenue via the US and in USD. During the last three years it has been making investments with a view to scaling the operation and, during the 2020/21 financial year, had a clear goal of returning 10% net profit margin (NPM) to the operation. Using a market order, the company was able to target a very aggressive USD-GBP rate and entered the market at a rate that was 12% better than was available the previous month, effectively revaluing its USD revenues by this figure and immediately achieving its year NPM goal. It then used a forward contract that crystallised this advantage for the remainder of the year to continue to value its USD at this contract rate.

 

A focus on the African Market

From Xe’s perspective, several of the economic headwinds facing global markets have taken their toll on investment into Africa. In these conditions, protecting risks to costs and managing FX hedging tools appropriately with a robust credit application is the key to ensuring the market volatility has as little effect as possible on investment operations.

Over the course of 2020 the FX markets have seen major exchange crosses fluctuate by 17% in the case of GBP to USD and around 14% in GBP to EUR. In terms of EUR to NGN (Nigerian Naira) we have seen an 18% change in rates, and 20% in EUR to GHS (Ghanaian Cedi). These enormous shifts in prices directly affect not only initial costing exercises but also yield expectations when projects have progressed beyond breakeven points.

At Xe, we have seen an increase in the use of clauses that enable readily updatable FX input costs for project forecasts and a significant increase in cancellable hedging tools, specifically vanilla options. Vanilla options are of particular use in less favourable economic climates since they offer full protection of a bottom line if the FX markets work against you. They could offer full advantages if the FX markets work in your favour. And, in the event of a deal being incomplete, the holder of the hedging tool may walk away, only forfeiting a relatively small down payment.

The most effective management of credit to support hedging tools has generally been to provide as much comfort as possible in terms of balance sheet and cash position to your FX broker. This may mean being tactical about which entity in a conglomerate holds the hedging tool or may mean offering parental guarantees where appropriate. The pay-off for this is that you may offboard a hedging tool from your balance sheet, leaving you free to acquire critical funding facilities at your principal debt vendor. The other major pay-off is that you could achieve the best possible cash conditions to manage your hedging tool. This means you could neutralise the requirement to set aside cash to pay margin calls on your long-term hedging.

To discuss your situation in more detail and find out how the team at Xe can support your business in managing its currency exposure, contact Ciaran.Pennington@xe.com or lewis.parson@xe.com or visit www.xe.com/business

 

The details expressed in this communication are for information purposes only and are not intended as a solicitation for funds or a recommendation to trade. XE Money Transfer, provided by HiFX Europe Limited. HiFX is authorised by the Financial Conduct Authority under the Payment Services Regulations 2017, registration 462444, for the provision of payment services. Registration number 12131222. HIFX accepts no liability whatsoever for any loss or damages suffered through any act or omission taken as a result of reading or interpreting any of the above information.

HiFX is a limited company registered in England and Wales. Registered number: 3517451. Registered office: Maxis 1, Western Road, Bracknell, Berkshire, RG12 1RT.