How do SMEs hedge in the UK compared to the rest of the world?

Businesses that leave market fluctuations to dictate the cost of their foreign currency payments are gambling with both their expenses and their profits. Unpredictability is a fact of life for the currency markets, but it doesn’t have to be for the businesses sending money overseas.

There are many tools and strategies available to help businesses hedge against risk from the fickle currency markets. Worryingly though, when compared to their international counterparts it seems that UK SMEs are reluctant to hedge.
 

UK businesses hedging less than overseas counterparts

While UK companies protect themselves better than their peers in France or Hong Kong, according to research by East & Partners Europe, the number of businesses using risk management tools like FX options and forward contracts remains below 40% – somewhat below the global average.

This compares unfavourably with Australia, where nearly 50% of businesses use FX options and/or forwards, or New Zealand, where 40% of businesses use FX options and an impressive 78% use forwards.
 

Why do UK risk protection rates lag behind the antipodes?

So why aren’t UK businesses hedging? Two reasons that are likely to be behind the higher adoption rates of risk management tools in Australia and New Zealand are currency volatility and a reliance upon exports. Both the Australian dollar and New Zealand dollar are commodity-correlated currencies, susceptible to react to large swings in the price of these global markets.

Additionally, the antipodean economies rely heavily on exports, so a larger portion of businesses are heavily exposed to changes in the currency markets.

The UK economy, by comparison, is driven mostly by services, which account for nearly 80% of economic output. Up until now many SMEs may not have bothered with hedging, or even been unaware of the process, because the pound was a relatively stable currency.

Brexit increases the need for UK businesses to hedge

However, since the Brexit referendum, the pound has become a much more volatile currency. Uncertainty dominates the UK’s economic and political outlook to a far greater extent than before the independence campaign began.

During August 2017, the GBP/EUR exchange rate fluctuated by nearly four cents. On a monthly transfer of £100,000, a business would have lost -€3,908 if it made the payment at the lowest point of the month compared to the highest – a difference which would amount to nearly -€47,000 over the course of a year.

A similar performance has been seen in the first half of November, with the pound to euro exchange rate weakening from a high of €1.1446 to a low of €1.1099. As you can see, sharp movements are not rare occurrences for the pound these days.
 

UK businesses waking up to the need for hedging

The increased potential for big swings in Sterling exchange rates has seen businesses turning to hedging as a way of controlling their costs, protecting profits and maximising cash flow visibility.

Perhaps businesses are only just becoming aware of the benefits of hedging because UK domestic and international banks are the primary spot FX provider for 82% of businesses. Specialist currency brokers are able to offer a more dedicated service to business clients, with leading providers offering personal account management and the expert guidance necessary to form a bespoke hedging strategy. On top of this, taking smaller margins on the currency they buy wholesale means brokers can often offer the client a better exchange rate than a high street bank.

Many businesses may also be labouring under the belief that hedging is hard, or is something that only larger businesses can or should do.
 

A new approach to FX hedging

There are many useful tools available to mitigate the risk of currency market movements. However, rather than delving straight into product offerings, businesses should first consider their core financial objectives. Ask yourself the following:

• How vulnerable are your margins to exchange rate movements?
• Are you working to achieve a particular budget rate?
• Is the timing and volume of your future transactions known or estimated?
• How volatile are your required currency pairs, and what is the market outlook?

Armed with these answers, you can establish some clearly defined objectives to inform your hedging strategy – including the percentage of your transactions that you should hedge and the balance of products best suited to producing your ideal risk vs reward profile.

Rather than trying to second guess rate-movements, businesses that hedge according to their core objectives can achieve more predictable cash flows that underpin their future growth plans and allow management to focus on beating the competition rather than the FX market.

Currencies Direct’s risk management team work closely with international businesses to plan and execute tailored hedging strategies. We offer expert consulting services, supported by one of the most diverse hedging product ranges in the industry, to ensure your business priorities are at the forefront of every hedging decision.

To begin a conversation about your own hedging strategy, please contact us using business@currenciesdirect.com or ring +44 (0) 20 7847 9269 and we’ll be happy to help.