Insight & Analysis

Managing FX risk in a volatile world

Published: Jun 2019

Implementing best practice in mitigating currency risk is essential for treasurers as they look to navigate an increasingly challenging trading and economic environment.

In light of current trade tensions, global economic slowdown and the ongoing Brexit talks, businesses have a challenge on their hands when dealing with currency fluctuations and exchange rates. However, there are ways to minimise risks by taking certain actions to mitigate the uncertainty.

Stephen Hubble, chief analyst at treasury management specialist Centtrip, believes the challenging operating environment and outlook for firms means it’s never been more important for treasurers to exercise best practice in managing currency risk.

“A currency strategy and ability to accurately forecast are critical for businesses looking to manage foreign exchange risks and minimise potential negative impact on its bottom line,” says Hubble. “When looking to protect against currency fluctuations, forecasting exchange rates is never an exact science, especially in the light of ongoing Brexit talks, trade tensions and a global economic slowdown. However, in times of extreme uncertainty there are actions businesses can take to reduce these risks.”

Hubble points to a number of best practices that can help businesses manage currency exposure. Firstly, he suggests simplifying bank account structure by adopting account structures that match business flows and reducing the number of accounts where possible: “Today’s technology allows you to do that by holding one multi-currency account – with a bespoke “sub-account” hierarchy for centralised cash management. It provides you with tailored reporting options to view specific business activities and transactions in real time.”

Secondly, firms should aim to free up time and liquidity through automation. Hubble explains that holding cash in different currency accounts may leave the business exposed to increased risk of currency fluctuations but by implementing multi-currency accounts, real-time visibility and control of finances is secured all in one place. “It also means foreign exchange is no longer a separate task but is embedded into the end-to-end treasury management process and integrated within the bank account structure, helping to eliminate any idle currencies and reduce aggregate exposure to FX volatility.

“Another way automation can help is through direct integration of your accountancy software – Xero, Sage or QuickBooks – with banking or fintech platforms. This arrangement will help improve understanding of treasury data and streamline cash flows in different currencies.”

Hedging tools

Thirdly, treasuries should break down their costs, understand what fees they pay and when. Hubble says that many businesses still use a traditional FX provider, not realising they charge “hidden” costs. In the same way, it is worth reviewing business travel expenditure, in particular credit card costs: “Many of those will come with hefty FX charges and admin processing fees when using them abroad. Very often that amounts to an extra 3–5% of the transaction value. So, it’s worth looking into prepaid multi-currency cards. Highly secure and accepted pretty much anywhere in the world, they allow firms to hold a number of currencies to suit their needs. They also often come with an app, enabling you to track and reconcile spending in real time.

Hedging tools should also be maximised, as forward contracts are useful: “They enable you to lock in an exchange rate in your preferred currency for up to two years, which can be used for future purchases. Typically, forward contracts require a securitisation deposit of 2–5%, which does not tie up your cash flow, yet gives certainty in the medium to long term.”

Treasuries should look too to set a realistic internal target currency rate when budgeting, analyse the current market conditions to gauge potential fluctuations and their impact on your profit margin and remember that markets move down, as well as up. “Gain flexibility by hedging a proportion – maybe 50% of what you may need. That way you could take advantage of the rates if they go up,” says Hubble.

Lastly, he urges treasurers to consider fintech: “It is so easy to default to established relationships so it is important to review them from time to time to make sure you use the most cost-effective and efficient options available. “Surprisingly, almost one-third of businesses still believe high street banks offer a competitive exchange rate, while nearly a quarter do not consider a specialist fintech company as a cheaper alternative, missing out on significant savings and solving operation inefficiencies.

“Technology can streamline and speed up your payments, and often for a fraction of the cost you used to pay. For example, automated currency rate tracking helps you obtain real-time quotations, allowing you to respond to currency market moves instantaneously. And AI and machine learning in the forecasting process can play a part in mitigating FX risks by helping explore different scenarios and stress testing your exposure to currency volatility.”

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