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How to protect your business against foreign exchange risk

Question: How do I protect my business against foreign exchange risk?

Brian Telford, head of markets at Northern Bank explains:

A: Any business involved in trading with counterparts outside the UK will be subject to an element of foreign exchange risk — a risk which should be managed like any other business risk.

The foreign exchange (FX) market is the largest market in the world with trillions of dollars being traded daily for both speculative and commercial purposes. It is a notoriously volatile market that can seem complicated and although you cannot influence the market itself, you can influence the effect it has on your business.

Having decided that you want to manage the FX risk, it is important to identify what it is and how it affects your business by understanding when, how and why the risk arises.

Possible risks you may encounter relate to exporting such as being paid in a foreign currency or importing and the need to pay suppliers in a foreign currency.

Once the risk has been identified and quantified, a strategy should be devised to manage it. While there are many ‘products’ that will help, the challenge is to find the solution that works best for you.

Increasingly businesses with cross-border trading are taking a portfolio approach.

This includes measures such as spot and forward FX contracts, cash management optimisation through currency swaps which make your current and future cash flow work harder for you, and examining the possibility of sourcing and selling in the same currency.

This limits the currency risk to your profits and may incorporate currency borrowing as an alternative to currency trading. For those with more experience and perhaps a more complicated profile, currency options may provide an alternative flexible hedging tool, particularly if volumes are |significant.

A discussion with your accountant or markets adviser is important in identifying the most appropriate ‘mix’ for your business. Once a strategy has been decided, it will only be effective when implemented and reviewed regularly.

As your business evolves, you may need to ‘tweak’ your strategy to cope with any changes and ensure that it continues to manage your foreign exchange risk.

Question: As a business owner are there any alternatives to |investing in pensions for me to reduce my tax liability?

Stephen Hill, senior partner with S Hill & Co Investment Advisors, replies:

A: Venture capital trusts (VCTs) are enjoying a renaissance this year as markets rebound and traditional tax shelters come under attack but I would recommend these to most clients as an additional tax-efficient means of saving as opposed to a replacement of pension contributions.

A VCT is a highly tax efficient UK closed-end collective investment scheme designed to provide private equity capital for small expanding companies and capital gains for investors.

They are a form of publicly traded private equity and they are companies which are listed on the London Stock Exchange that invest in smaller companies which are not.

They traditionally experience a flurry of subscriptions in the run-up to tax year end, and this year was no exception.

VCTs were on target is to reach £515m by April 5. While that is lower than the £700m raised in 2005/06, it would mark a substantial increase on the £300m raised over 2008/09.

A recent report published indicates that there has been a change in the sort of investor using VCTs. While interest in VCTs in 2005 related to a flourishing market and a generous 40% tax relief, this year they are attracting smaller, retail investors looking for an alternative to pensions. There are currently 31 VCTs open to investors. The schemes are grouped in three categories: generalist, AIM-traded and those investing in specialist sectors such as technology. Of the VCTs that are open, seven are top-ups, meaning they are only open to existing investors, and 11 are limited-life.

As with all matters relating to your business and personal investments and tax liability, I would recommend consulting your account and your Independent Financial Advisor before deciding any major change to your savings and investments.

Belfast Telegraph