Belfast Telegraph

You can't just sit back and do nothing if you're managing currencies

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By Bryan Telford, Head of Markets, Danske Bank

When the UK Government triggered Article 50 and started the formal Brexit process, I couldn't help but remind myself of a line uttered by Jim Lovell, commander of Apollo 13, as they launched their Saturn V rocket: "That's it guys, a few more bumps and we're hauling the mail."

I was drawn to the comparison because, now that we have officially embarked on our Brexit journey, there will undoubtedly be some bumps along the way, not least in the currency markets.

Both sides of the negotiation are indicating that the outlined timetable will be delivered. However, many knowledgeable commentators hold a different view and believe some kind of transitional arrangement is inevitable.

There is little doubt that headline surprises have the ability to introduce significant volatility into currency markets. For now, I would contend that we adopt a 'business as usual' approach to managing this ongoing risk. In currency markets, two years is a very long time.

The level of divergence in sterling forecasts being published leads me to conclude nobody really has a clue what is actually going to happen. In a recent review of multiple forecasters, the spread between the high and low forecasts for GBP/EUR in 2017 was circa 40 cents. That is pretty wide in anyone's book.

Those arguing for a stronger or weaker pound can no doubt make a convincing case either way, whether it be a hard Brexit slide for sterling, or potential political instability in Europe leading to a weaker euro.

It may seem rather obvious, but we should never take just one view. Human nature often leads us to lean towards a forecast aligned to our specific business need - commonly referred to as, 'my position dictates my view'.

As a risk manager, I would argue that it is never too volatile to hedge, provided there is timely planning to identify and quantify the risk. I would advocate a 'back to basics' approach to managing exchange rate risk. Now may be the perfect opportunity to review, or indeed introduce, a currency risk management strategy for your business. Simply doing nothing is not a strategy.

Becoming comfortable with favourable exchange rate moves could cause some businesses to lose sight of budget exchange rates only to find they are not where they need them to be when they need them to be there.

And even though it may not be immediately obvious, if your product or service starts life or ends up outside the UK, you do carry some level of exchange rate risk. Depending on your particular business, you may have limited ability to influence this aspect, for example where the only mechanism to trade is through UK-based distributors.

Perhaps, as a mitigant you can target new markets where your products now offer better value?

By assuming your customers are happy to pay you in sterling, you will be placing the exchange rate control into their hands. This may not manifest itself until your sales volumes fall.

I would imagine few importers would be able to absorb the fall in sterling since the referendum without some impact on cashflow.

It is worth checking what shape your competitors are in, rather than assuming that they are in the same boat. You may have a competitive advantage or disadvantage depending where they are geographically, relative to you.

Renegotiating prices based on exchange rate changes will not, in itself, hedge exchange rate risk. It can certainly mitigate the risk to some extent, but it is more a resetting of the starting point than a final solution. If you still need to exchange currency, then you carry residual risk.

Currency volatility is rarely the friend of business. You may get lucky and make windfall profits, but it would be unusual if this continues over time.

It is also important to ask yourself what you want to achieve in your currency risk management approach. Consider whether you are a currency trader or focusing on your core business. This may determine how much time you spend managing this risk.

The point when currency exposure arises is generally the optimum point at which to hedge the risk. If you decide not to hedge, understand the actual financial risk in monetary terms - opportunity gain versus actual cost.

The optimum product solution, in which businesses can dictate that they are paid what they expect to be paid, should come out as part of the analysis of foreign exchange risk for the business.

I am confident most of you can remember Commander Lovell's more famous utterance, made only two days later: "Houston, we have a problem." Lovell captained the ill-fated 1970 Apollo mission to land on the moon that had to be aborted. In spite of the grave risks faced, Lovell and his crew successfully returned to earth, through a mix of their own skill and support from their ground crew.

History now tends to view the Apollo 13 mission in one of two ways, either as a flawed operation or as NASA's finest hour. I will leave it up to history, and you, to judge how Brexit will be viewed, but with a focus on understanding the risks, the opportunities and agreeing a plan of action, the currency bumps will hopefully be overcome.

Belfast Telegraph

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