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FX hedging strategies to protect your business

FX hedging strategies to protect your business 37

By Laurent Descout, Co-Founder and CEO of Neo.

Earlier this year, multinational corporations in the U.S. and Europe reported a loss of $9.5bn in Q1 2021 due to currency volatility.  If even the largest corporates with hedging experts are losing money, how are SMEs expected to fare, with fewer staff and smaller budgets? Laurent Descout, co-founder and CEO at Neo, looks at how businesses can identify, manage and hedge FX risk.

While volatility may be considered “low” for those seeking alpha, many corporate treasurers do not share that view. EUR/USD went from 1.18 to 1.12 over the last 12 months and that in itself is enough to be of great concern to most companies.

There are also meaningful macro changes on the horizon, such as the potential end or softening of quantitative easing policies and higher interest rates, ongoing issues in the global supply chain and a shortage of drivers for goods transportation in some countries. FX hedging and risk management should remain at the top of the agenda for most corporate treasurers.

With this in mind, here are some simple ways you can help protect your business from FX risk:

Create your hedging strategy

Many SME owners don’t have a corporate hedging strategy in place. Rather, they rely on spreadsheets for their forecasting, cash flow and accounts and stock management. This is simply not feasible nor sustainable.

Regardless of your business size or revenue, we are all affected by geopolitics, trade issues, tariffs and more – all of which can affect currency movements or the amount you pay for goods and services. Many of the largest corporations spend tens of millions on banks and consultants for the best advice, but small businesses are not afforded the same luxury.

Fortunately, recent advancements in fintech mean it is possible to access all the key services SMEs need for their corporate hedging strategy – multiple currency accounts, automated payments and collections, forecasting tools, FX hedging and risk management – at an affordable cost.

So why wait? Do your research and find the best system for your business.

Identify the risks and set your priorities

It is crucial to identify where the currency risks are in your business. It could be related to cash on your balance sheet, payables, receivables or a specific contract with a new supplier.

Once you have pinpointed the biggest areas of risk, set your priorities. For a small business, it is difficult to mitigate all of the currency risks all of the time – especially if you’re implementing a corporate hedging strategy for the first time.

There is no “one size fits all” approach, but we have seen strong demand for simpler hedging products such as FX forwards and vanilla options. These hedging products are simple and secure, easy to understand, are relatively liquid and can be unwound easily if market conditions or risk appetite change

Be realistic and set short-term and long-term targets. Focus initially on the areas that are likely to affect your business the most and build from there. Set timeframes for evolving and expanding your strategy. Remember, Rome wasn’t built in a day!

Choose a suitable partner

A decade ago, many corporates had specialists in-house and external advisers dedicated to treasury management, corporate hedging and how, when and where they should buy or sell currencies in order to secure the best exchange rates.

Evolution in technology, lower barriers to accessing advanced systems and knowledge sharing have rendered much of this irrelevant for SMEs. However, there are still a couple of key things to look for in a partner.

To start with, check they are regulated to provide payments and currency-related services. If they offer an automated or cloud-based service, make sure they have robust technology, operational and security features in place.

Second, ensure you are offered direct market access to credible currency exchanges and venues, and hedging products that you understand. This cuts out the need for a bank and will save you money in the long-term.

Third, make sure there is full transparency in relation to the FX fees you are charged. Historically, this has been an area of contention and SMEs can easily overpay without realising they are doing so.

Spread your money across multiple accounts

You may not be familiar with this concept, but this is something that is increasingly gaining popularity, especially if you are exposed to different currencies.

Many SMEs are required to have different bank accounts for different currencies, many of which operate in silos. As a result, they are unable to view their cash flow in real-time and lack full financial visibility across their business.

Some SMEs are still reliant on banks to execute and exchange their currency orders, resulting in long lead times and high commissions.

A multi-currency account service (also known as an IBAN) is a great option for holding currencies and organising your funds. As you are receiving or making the payment in the same currency as your counterparty, there is no need to hedge or convert it. You can access the currency immediately, which improves cash flow.

Make use of data and analytics

Every SME’s trading history, payment cycles and cash reserve levels are different. Business owners make decisions to manage these on a daily basis, but how can you be sure that the decision you make is the right one, and it is made at the right time?

What many business owners may not realise is that they are sitting on a treasure trove of information that could go a long way towards helping them in this regard. By using tailored data and analytics derived from their company’s history of trading, payments and cash flow, business owners can have a complete view of their corporate behaviour, backed by unique data and intelligence.

Ever wondered if payments are made on time, or even too early? Or what percentage of customer payments are delayed, and by how much? Are there common trends that are being overlooked? How can temporary cash shortfalls be addressed more effectively?

Knowing the answer to such questions and more can result in improved forecasting, detecting patterns and anomalies and automating processes. This enhances financial decision-making, risk management and cash flow monitoring. Critically, the answers derived from these analytics are unique to each business.

Innovate to drive efficiency

SMEs are often the biggest drivers of innovation and economic growth. It is crucial that they adapt and evolve their existing processes to overcome the current challenges. Technology is the key to achieving greater efficiency.

The past 12 months highlight the importance of accurate forecasting and protecting against sudden movements in currencies. These can affect the cost of raw materials, import and export costs, margins and ultimately, profits.

In this period, we have seen our clients hedge their supply costs and lock in prices for the foreseeable future to provide certainty regarding the cost of purchases. This has been proven to be even more important as raw material and shipping costs, which are mostly denominated in USD, surged.

It is time to shake off Excel and embrace the technologies that the largest companies in the world have been utilising for years. This will reduce time constraints, offer greater oversight of your business in real-time, and derive analytics and intelligence to help you make better decisions.

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