ACTS, Treasury

A Case of Brexit - Managing Currency Risks

April 02, 2019
In Collaboration With

NTU Risk Management Society

FX Risk Management has always been a fundamental responsibility of the Corporate Treasurer. With increasing market volatility, the importance of having good FX risk management and policies in place is larger than ever. Increasingly, Governments and Regulators around the world have increased scrutiny over the usage of the FX Markets and introduced a set of Global FX Code of Conduct.

NTU Risk Management Society is proud to have invited members from the Association of the Corporate Treasurers (Singapore) to hold a panel discussion for our members and fellow students. During this lunch time presentation and panel discussion, senior corporate treasurers from well-known multinational companies like Grab, STMicroelectronics and Nestle will be sharing their experiences and insights in managing this daunting challenge but rewarding role.

We hope that the audience will be able to hear firsthand from the practitioners and learn about their interesting roles and exciting experiences. Also, we hope that there will be an engaging Q&A session, where we will ask them about their challenges and their opinion of the ever changing regulatory landscapes. Below is a writeup by our members, Qiu Yiming and Jolene Low on Brexit and the case for currency or foreign exchange (FX) risk management.

Overview of Brexit
The European Union was formed after the World War Two with the noble idea of creating a ‘single market’ to spur economic recovery and achieve greater growth synergies amongst European states. However, over the years, nagging problems from the influx of legal and illegal immigration from the poorer states and potential threats to national sovereignty and actual cases of terrorism were raised up amongst the Britons.

These factors culminated to a referendum by then Prime Minister David Cameron that was held on 23th June 2016 to decide whether UK should remain or leave European Union (EU). The result of the contentious referendum showed that 52% of the British populace voted to leave EU. The Lisbon Treaty was invoked on 29th March 2017 which triggered formal notice and negotiations of the split. The continued uncertainty on the prospects of the Brexit deal has resulted a disarray in global stocks and currency market i.e Sterling/Euro (GBP/EUR), Sterling/USD Dollar (GBP/USD) exchange rate. Before the Brexit vote, sterling was trading at €1.45. In 1H18, the average rate has been about €1.32.

Effects of Brexit
Weak GBP is a major concern for companies exporting their goods and services to the UK . This is especially so for neighbouring countries, such as Ireland, which exports significantly to the UK. Their receipts in GBP are facing massive negative pressures.

Meanwhile, it is increasingly costly for British importers who need to pay in foreign currencies, and increasingly difficult for British companies to invest overseas. For example, UK companies looking to invest in Singapore will have to grapple with a scenario where SGD investments are expensive in the face of a depreciating GBP.

On the flip side, a weaker GBP might be attracting capital inflows to UK from opportunistic foreign investors who find undervalued assets due to the depreciating GBP. Consumers in countries where currencies are strengthening against GBP have been enjoying a “Brexit boom” and are now able to enjoy British goods and services at a discount. Students with shoestring budgets are now finding London and UK much more affordable than before!

Managing currency risk
The volatility of the GBP will certainly affect the bottom line of any Multinational corporations (MNCs). Whether it is a firm that imports raw materials from UK, or a corporation that exports and receives GBP, the fallout from Brexit on GBP is a cause of concern for Corporate Treasurers.

Thus it is important for MNCs and Corporate Treasurers to employ currency risk management strategies in order to reduce the volatility of their cash flows and protect their profit margins.

Typically, Corporate Treasurers when managing currency risk, they consider instruments like:

FX Forward Contracts
Forward contract is an agreement to lock the exchange rate for the purchase or sale of a specific amount of foreign currency on a future date. This mitigates exposure to adverse movement in exchange rate. However, as the forward rates are fixed, there is no opportunity for the hedges to benefit from favourable exchange rate movement during this period.

FX Options
Generally speaking, there are 2 types of currency options - call options and put options. Call options allow the buyer the right to buy the currency at a predetermined price upon expiration; put options allow the buyer the right to sell the currency at a predetermined price upon expiration. Unlike forwards, it is not mandatory for the buyer of options to execute their right to buy/sell.

The graph above illustrate the protection from using FX options. Options protect companies against huge loss because of the depreciation of the currency they want to buy, thereby allowing these companies to hedge currency risk. When one purchases an option, the maximum he can lose is the premium (or cost of option).

FX Swaps
A currency swap is an agreement between two counterparties to exchange one currency for another currency for two different dates. Similar to a FX forward contract, FX swaps enable companies to manage their FX liquidity risk by swapping one currency for another in the near term, and only to reverse the position in a later date. 

For example, a British Exporter needs to pay its suppliers in SGD in a week, but is expecting to receive SGD from its investors in 3 months will enter into a Buy/Sell SGD vs GBP for value date 1 week vs 3 months.

Natural Hedging
Natural hedging refers to adjusting the revenue/cost structure of a business in an attempt to nett its payables and receivables in the same currency and thereby reducing its exposure to currency risk.

For example, in response to the depreciation of Sterling, Irish producer Codd Mushrooms Ltd whom exports to UK, plans to operate in the UK to lower the currency risks. By shifting its costs base to GBP, the Irish firm is attempting to natural hedge its huge GBP revenues. These operational risk management measures help to match costs with revenues, thus mitigating currency exposure.

Businesses with international exposure will certainly be affected by the Brexit and its ripple effects of volatile exchange rates. Businesses should be proactive in establishing risk management departments to routinely access and review risks exposures to find solutions to mitigate these risks.

The decision to hedge is determined by a few factors such as business’ risk appetite, treasury policy, long-term contract commitments, supplier payment cycles and underlying business margins. Companies should consider these factors prudently when choosing their best risk management strategy.

about author

Risk Management Society (Nanyang Technological University) is into its 19th year. Risk Management Society was founded in 2001 as a student chapter of the Risk and Insurance Management Association of Singapore (RIMAS), a non-profit organisation aimed at advancing the discipline and practice of risk management. We are the student body dedicated to promoting risk management among students in NTU. Our vision is to be a premier institution bridging students and the risk management industry through creative and relevant partnerships, activities and publications. This article has been prepared by Risk Management Society’s Research Department, whose vision is the advancement of the knowledge base through research. All enquiries could be redirected to [email protected]