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Manage currency exposure

Uncertainty from Brexit requires businesses with exposure to the UK market to manage currency risks or see hardwon profit margins eroded, writes Philip Ahearne.

The year 2016 will be forever remembered as the year the British electorate voted to leave the European Union (EU). From a currency perspective, sterling has weakened substantially since the outcome of the referendum became clear. On the night of the election itself, sterling weakened against the euro by approximately 10% as it became apparent that the ‘leave’ campaign had been successful. The uncertainty that remains over how the actual exit process will play out has caused continued volatility in sterling and this is likely to remain in the short-term at least. The appointment of Theresa May as the new Prime Minister did lead to a slight rebound in sterling and she now faces the challenge of leading the UK through the exit process. 

While this has been a significant political event, it is in reality another example of how macro factors can impact currency markets. It serves to highlight the volatile nature of the currency market and similarly serves to highlight the importance for companies with foreign currency exposure of managing those exposures efficiently. If we leave aside the issue of trade barriers, which will undoubtedly arise in the months and years ahead, the weaker sterling actually offers opportunities for Irish companies importing from the UK as their product becomes relatively more affordable. The opposite applies for exporters to the UK. 

How to mitigate currency risks 

Managing currency risk is critical in order to lock in profit margins. The suddenness of the recent fall in value of sterling emphasises how quickly margins can be impacted. Using some fairly straightforward planning techniques, it is possible to mitigate the risks related to currency volatility. It is generally accepted that there is no ‘best practice’ when implementing a foreign exchange hedging strategy, as exposures will vary from one entity to another. There are, however, a number of guidelines that can be followed in the short term that will be helpful: 

• Develop a strategy, which should be led by the company’s management and board 
• Know your company’s currency exposure and set realistic budget rates around it 
• Understand how your currency exposures affect your business. What is the impact on your organisation’s margins and how much can your margins deteriorate by before the organisation is materially affected?
• Reduce your exposure as much as possible. For example, can you invoice in euro? Can you use sterling receipts to cover sterling costs?  
• Have an understanding of how your competitors manage their currency risk. 

The best approach for your business 

Deciding on the best approach for your business can be challenging at best. There are numerous products and tools to assist you in managing currency exposure and it is important to choose those that best suit your needs. Remember, you are trying to reduce risk rather than increase risk by taking speculative positions. 

The Irish economy is strong and performing above the European average. Many businesses have shown great resilience throughout the recession and are well placed at this time. We remain part of the EU, a large market that affords opportunities and this cannot be ignored. It is important, however, that companies continue to observe other factors that Brexit will impose on trade with Britain. 

It is incumbent upon management and boards to develop strategies to deal with the evolving situation. The imposition of Article 50 will start a two-year process that will culminate in Britain’s exit from the EU. However, it may take longer than two years to conclude and this will lead to uncertainty and volatility over that time. Companies will therefore require a robust strategy to deal with currency requirements. 

Philip Ahearne is Head of Corporate Foreign Exchange Sales at Investec

This article first appeared in the August 2016 edition of Accountancy Ireland, published by Chartered Accountants Ireland. You can read the original here.