Friday 30 September 2016

SMEs must get to grips with swings in sterling to safeguard their future

Barry Dowling

Published 15/09/2016 | 02:30

Sterling is set to drop to 90p against the euro – and firms must look at hedging options
Sterling is set to drop to 90p against the euro – and firms must look at hedging options
Barry Dowling, Transfermate

Without sounding too alarmist, many Irish SMEs are leaving themselves exposed to fluctuations in Sterling as the currency plummets in value, which could have the potential to wipe-out profits for many exporting SMEs.

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With sterling to drop to 90 pence by December, we are advising Irish business who trade with the UK to move now to hedge against sterling, in order to protect their already significantly impacted profit margin - and there are three primary options available to Irish businesses to protect against currency fluctuations.

Only 12 months ago your euro would have bought you 70 pence. Post-Brexit, and the subsequent 21pc drop in the value of the pound, it is now heading for 90 pence. Irish businesses importing from the UK are likely to welcome a sharp drop in the price of imports from the UK. But Irish exporters are left having to consider 'hedging strategies' to guard against a likely further decline in the pound.

It's very important to consider where sterling is headed and what exactly that means for your margins. With many businesses working off a profit margin of 10pc-15pc, a 20pc-plus fall in price could push some into the red - thus threatening their viability and many jobs.

Reports from the UK earlier this year suggested 80pc of larger corporates have hedged against sterling exposure, but only 22pc of UK SMEs have - anecdotal evidence suggests to us that less than half that number of Irish businesses have taken steps to protect themselves.

What's the short-term future of the pound?

Markets are currently pricing sterling to drop to an expected 90 pence, and possibly even parity, by the end of 2016. A potential further decline of close to 20pc is also being considered. In recent weeks, Bank of England board member Ian McCafferty suggested that further rate reductions and additional QE purchases may be required if the UK economy shows further signs of a slowdown. One of the first things a business should do if they are sourcing from the UK is to contact suppliers and lock in pricing. With sterling weakening, UK suppliers will look to pass on price rises to Irish buyers as the cost of their own source of materials increase.

A weak pound - what does it mean for Irish business?

At this stage all businesses adversely affected by sterling weakness should be seriously investigating how to protect themselves against further fluctuation.

Even businesses that buy in sterling would be strongly advised to hedge against at least a portion of their exposure.

What options are available?

We would advise Irish businesses that trade with the UK to consider three options that could allow them to protect them from currency fluctuations:

1 Flexible Spot Facility

Similar to a forward contract, a Flexible Spot simply allows you to guarantee today's exchange rates for future currency exchange for a period of typically six to 12 months. Businesses may take the view that it is best to lock in today's exchange rates for a period, ie up to 12 months. This way you guard against fluctuation affecting your margins and know today what sterling is going to cost to convert in advance.

An example would be an Irish food distributor that supplies Tesco and Sainsbury in the UK with product and invoices amounting to approximately £150,000 every month. Over the course of the next six months, that business will receive £900,000, or close to €1,058,823, at today's exchange rates if fixed.

Should sterling move to parity, that £900,000 will yield over €150,000 less.

2 The 50/50 Approach

Some businesses will decide that protecting against the full exposure has the same risks as not protecting at all. In this case, an approach might be taken whereby the businesses calculates total exposure and protects against half of that.

In this instance above, this business may decide to protect against £450,000 of exposure. The benefit here is that the approach will be neither right nor wrong as you simply balanced your exposure.

3 Live Orders

A further demonstration of an option open to Irish business is a business that needs to pay £50,000. The exchange rate today is .86 and they feel that it may hit .87 this week, so they request an order for .87.

This order is now placed on the market and will be filled as soon as .87 hits. If sterling strengthens they can simply cancel the live order in the meantime. If .87 lands, the business saves close to €600.

Whatever measure you decide take, the message is simple: you need to act now. Those businesses that fail to move in advance of further drops in the pound are likely to suffer from their inaction further down the line.

Barry Dowling is co-founder of TransferMate Global Payments, Irish-based FX specialists

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