Protect FX exposure by mix of approaches
Ryanair recently warned it could miss its full-year profit forecast amid a noticeable dip in bookings for the coming months. Europe's biggest budget airline blamed a weaker currency in its largest market, Britain, along with growing competition – particularly in Britain, Scandinavia, Spain and Ireland.
What really caught my attention was the 'sterling weakness' element of the statement, bringing home how the management of foreign currency volatility is crucial to so many companies.
If you are an Irish-based entity generating revenue in the UK, or need to pay a supplier in the US or have just disposed of your Japanese equity portfolio, you have foreign exchange (FX) exposure. The distress that a sharp negative move in a portion of unhedged exposure in any asset class is always acute and FX isn't any different.
But, for Irish companies exporting to the UK – our largest non-euro trading partner – a strong pound is vital to profit margins, ie, as the value of the pound against the euro moves lower (eg from £0.82 to £0.87) they stand to lose money on unhedged exposure.
These companies have had a lot to deal with in recent years, such as the average value of sterling devaluing by almost 30pc against the euro. It has moved from £0.65 (average rate between 2000-2005) to £0.75 (average rate between 2005-2010) to £0.85 (average rate between 2010-present). That has been a massively unwelcome adjustment for any Irish company with sterling receipts.
But, while most of that movement has been gradual over 15 years, some of it has been very quick and incredibly aggressive.
The most notable of which was post the Lehman's liquidity crisis in Q3 2008, when sterling dropped over 25pc from just under £0.80 to over £0.98 in just under three months. Try hedging that!
It is these type of aggressive moves that have encouraged many CEOs and company boards to place targets or budget rates on their projected FX exposure in order to at least try to minimise loss of margin and estimate revenue, a worst-case scenario rate in effect.
Trying to gauge and calculate future exposure is never an exact science and the financial health of your company will dictate how much, and how far forward, you can hedge your FX exposure.
Most Irish corporates currently protect their FX exposure using traditional spot-and-forward FX hedging methods, ideally at or close to their target levels. Occasionally though, when the stars align and you are fortunate enough to beat or exceed your budget rate, the natural and human tendency may be to dive in and begin to cover your exposure, in essence locking everything in at a fixed rate.
You are then probably unable to partake in a potentially favourable move in rates as you have locked in most, or all, of your exposure. It is precisely then, before you begin to lock in that exposure that you should re-assess the situation.
If, and when, you find that elusive bit of wiggle room between the current favourable market rate and your budget rate, then try to use it wisely.
Treasury solutions providers can now utilise that breathing space that you may have to provide you with a suite of bespoke, innovative financial products that can be tailored around your specific FX hedging requirements. These products ensure you get a good night's sleep, safe in the knowledge that you are fully covered at a pre-agreed, worst- case rate but will allow you to participate in some portion of a favourable move in your direction in order to enhance or improve your overall average rate.
I certainly wouldn't advocate piling all your exposure against one of these products but we do recommend a portfolio-type approach with a mix of spot, forward and other hedging products.
So, if and when, FX rates happen to move in your favour and you find that bit of wiggle room, why not allocate some of your exposure to one of these products that may be tailored to your needs – you might be pleasantly surprised.