Market volatility has been reserved in recent times but there are signs the tide is turning. Laurent Descout, Founder and CEO of Neo, discusses the importance of FX risk management and why it should always be a priority.
2024 so far has been a relatively quiet year for FX markets. However, in the past month, volatility has started bubbling up again, bringing FX risk management to the fore for many businesses. In April, Bloomberg’s gauge for hedging swings jumped to its highest since January, influenced by the ongoing conflict in the Middle East and speculation that the Fed will have to hold monetary policy tight for longer.
In today’s digital world, even the smallest of businesses trade internationally thanks to e-commerce and, as a result, can be victims of currency fluctuations.
But all types of businesses have traditionally treated FX hedging like going to the dentist. When there are no negative symptoms, it’s rarely a priority – but when the pain starts, it quickly becomes an emergency.
Businesses should always be mindful of what could be around the corner. Regardless of their size or revenue, they are all affected by geopolitics, trade issues and tariffs in some shape or form, all of which can impact the value of currencies, the price they pay for goods and services and, ultimately, bottom lines.
Kyriba’s latest currency impact report revealed that the total annual currency impact for 2023 reached $95 billion, and this is just the largest corporates with hedging programmes, so the real impact is likely much higher.
CFOs and treasury professionals must have regular check-ups and implement strong FX programmes to protect themselves against these risks. However, there are some potential FX aches and pains they need to look out for along the way.
Traditional banks falling short
Banks have long been the go-to option for businesses seeking help and advice when it comes to FX hedging and currency risk. Over four-fifths of SMEs (83%) rely on traditional banks for their FX needs.
However, now as SMEs grow internationally, they are increasingly faced with significant challenges when they rely on banks for FX risk management.
Nearly half of SMEs (48%) struggle with FX pricing. Large corporates benefit from tighter spreads and better rates, generally getting a better deal due to the higher volume of FX activity they undertake. SMEs are paying over the odds with banks heavily marking up margins and inflating the overall price.
45% of SMEs suffer from slow execution. FX markets move quickly, so it’s vital SMEs can buy and sell currencies and effectively hedge their risk as quickly as possible. However, FX execution and hedging have been a widely mismanaged feature of small and medium-sized enterprises for years due to a reliance on banks and a lack of access to the right technology.
Just under a third (30%) of SMEs said that struggling to compare suppliers was a major FX pain point. Many SMEs rely on one or two banking partners, making it difficult for them to compare the market and know they’re getting the best rate.
SMEs that rely on banks also struggle with reporting transactions, poor customer support from experts and a lack of automation.
The significance of formal hedging operations
Hedging programmes allow businesses to lock in rates ahead of time, protect their commercial margins and can have a positive impact on their profit and losses. They vary from business to business. However, the simplest products, like forwards and straightforward options are often the most popular.
Most businesses will hedge up to a few months, with long hedging being quite rare because this provides a layer of flexibility and agility so they can respond to changing market conditions. Macroeconomic events such as elections or central bank decisions will influence currency markets, so having foresight of such situations will stand corporates in good stead when implementing their hedging programme. This will help ensure agility and protect their bottom lines.
Easing the FX burden
As volatility increases in currency markets so too does the urgency for businesses to act. Preparation is key and those that didn’t implement hedging strategies during times of volatility will know all too well the importance of doing so now.
It’s also beneficial for businesses to have the correct FX hedging facilities which are integrated with other services such as payments, cashflow, forecasting tools and risk management. This gives treasurers real-time visibility into cash positions and is a vital tool in decision-making.
Fintechs are stepping up to offer the tailored solutions banks currently don’t. Businesses can now make payments in a range of currencies from multi-currency accounts and allocate funds using virtual wallets, all from one place.
Stepping away from the traditional banking model will ensure businesses are best placed to gain greater resilience to weather current and potential future volatility and enable positive, long-term growth.
