Mitigating against volatile currency markets

Posted on 23 Aug 2012

Keith Miller, head of the dealing desk at non-bank business payments firm Western Union Business Solutions, looks at how small and medium-sized businesses can take the edge off their exposure to volatile markets against the backdrop of renewed European uncertainty.

For many British importers and exporters, currency volatility is a big concern. A sudden shift in exchange rates, and a profitable deal can all of a sudden lose value, or in an extreme case, turn into a loss-maker.

The financial troubles in Europe have caused much grief and worry.  One of the major concerns during the first half of 2012 has been in relation to the mounting threat of a Grexit (Greece’s potential exit from the euro.)

Over the last few months, as the Greek situation has intensified, the spotlight has remained firmly fixed on European financial markets. UK-based importers and exporters need to be assured and reassured that their European suppliers will not be adversely affected by the potential fallout of Greece leaving the euro.

As has been well documented, the worry is that a Grexit would be the catalyst for other nations and economies to do the same. Spain, Portugal and Italy are all in precarious positions. How can businesses mitigate against all this uncertainty?

Quite simply, and as has been the case following several years of economic instability, small and medium-sized enterprises need to be financially-savvy. With such uncertainty in Europe, businesses need to remain in a position where they can continue trading internationally while not putting their own livelihoods at risk.

A lot of solutions exist to help businesses protect against market volatility, at least in the area of foreign currency payments.

Forward contracts/FX hedging

The pound has steadily strengthened against the euro in the first half of 2012, ranging from a low of €1.18 (24 Feb) to a high of €1.26 (15 May). News of a weakened euro has helped some of our customers, particularly those importing from the eurozone. SMEs buying in euros could consider making a forward or future payment.

This enables businesses to lock in international payments at a fixed exchange rate, so as to manage their costs and avoid being subjected to volatile currency fluctuations.

By fixing the exchange rates of their international payments, businesses will be in a better position to manage their outgoings, and will therefore be better equipped to cope with unforeseeable market disruption and other external variables.

SEPA and direct payments

The EU’s Single Euro Payments Area (SEPA) was designed to simplify bank transfers. The reality of SEPA has been somewhat marred by missed deadlines and delayed legislation, to the extent that there is still a lot of inefficiency when one eurozone country makes a cross-border payment to another eurozone country.

By contrast, businesses based in the UK are able to make direct payments in the currency of their choice, at their chosen fixed rate.

The clarity and efficiency that stems from fewer bureaucratic hurdles is a luxury that UK importers and exporters should not take for granted. The ability to make direct euro payments at a fixed rate means that companies from the UK are far more efficient in making overseas transactions, and are well-placed in comparison to their European counterparts when making international transactions.

Overseas payments (such as remittances) will not be overly subject to delays and UK businesses will generally receive their payments on time, which will help with their own liquidity. Most significantly, international relationships will not be damaged through unnecessary red-tape disruptions; strong business relationships are vital in these days of uncertainty.

Alternative markets

One of the more significant announcements for international trade was made at the start of the year, when the UK Treasury confirmed the development of London as the leading international hub for trading China’s currency, the renminbi.

This was a momentous decision that places both the UK and London as the go-to market for Western economies when they want to do business with China.

Treasury officials are confident that the new partnership puts London in a strong position to be a major centre for trading the Chinese currency outside China and Hong Kong; they have forecast that trade transactions settled in the Chinese currency would reach around £650bn by 2020.

This move has the potential to change the very landscape of international payments and will catapult UK SMEs into more global markets. In essence, it will make it easier forUKbusinesses to benefit fromChina’s exponential growth.

China’s economy grew by 9.2% in 2011 and has predicted a 2012 growth rate of 7.5%. By comparison, the eurozone grew by just 0.1% in 2011 and is predicted to contract by 0.3% in 2012.

In short, there are three essential tips that UK-based importers and exporters can consider when they’re looking to minimise the impact of the European financial crisis on their business. It is essential for companies of all sizes to be ‘financially-savvy’ ahead of what looks to be a turbulent remainder of 2012.