Among the top performing firms, 63 companies achieved operating margins that were in double-digits. Meanwhile, the latest BPIF Outlook report highlights the pressure on printing industry profits from soaring input costs, including energy.

As Tesco says, ‘every little helps’, and in terms in excising cost, the obvious targets are staff, premises, fuel, utilities, and raw materials. But how many think about currency – especially where a printer directly imports or exports to, say, Europe and the payment – in either direction – isn’t made in sterling? Do they ever consider what would happen if the euro moved 2% the wrong way?

Protect the position

The problem of currency volatility is important to Tom Foster, senior corporate dealer for Central FX. He knows that “very few people, if any, can reliably predict the movement of currency markets”. Further, he says, “failing to sufficiently protect your business against adverse rate movements can lead to significant and unforeseen losses on your bottom line”.

It’s also why David Johnson, director of Halo Financial considers that protecting a company’s position on foreign exchange needs “is no different to any other kind of good governance”.

But just as no two companies are the same, so Foster sees risk profiles of different firms as always being different. However, he says that “as a rule of thumb there are some general considerations that should be made”.

In more detail, he says that “any business involved in foreign exchange should have a budget rate they work from. This can be used to forecast costs when importing or exporting goods”. 

“It is essential this rate is protected to some degree. Failure to do so coupled with adverse rate movements can mean that profit margins are eroded. Firms will then be forced to hike prices to combat this, something that won’t typically go down well,” he says.

Foster therefore sees a fine balancing act between no protection and too much protection.

And Johnson agrees. He too sees that without any exchange rate protection, there is a risk of writing off profit or even creating a loss. On a positive note, “there is a possibility that the exchange rate could move in the company’s favour”. But that, as Johnson, says, is “like managing risk based on a coin flip”.

Risk options

How a firm manages its risk will depend on its appetite, and in Johnson’s view, it’s all about a strategy that “covers a percentage of the open positions and increasing that cover as the payment dates or revenue receipt dates approach”. He says that some firms work on a 50%/30%/20% strategy, where 50% of all known currency needs are covered as soon as they are certainties, 30% is covered nearer to the settlement dates or if a sizable swing in the rate is seen, and 20% is left until near the settlement date. He sees larger corporations favouring a more structured approach, while smaller owner managed businesses tend to be more agile.

As to the tools that can be deployed, there are a number which Johnson outlines.

There’s the forward contract that gives certainty over the exchange rate and removes any risk. A downside is that the company cannot use it if the exchange rate improves. Also, it often requires the payment of a deposit or bank charge over some of the company’s assets to mitigate their risk.

Next is the spot contract. This removes risk, but trades are settled immediately. These are useful for cash-rich firms with currency accounts that can switch funds between currencies; it’s less of an option where cashflow is tight.

Another possibility is the bracketing of exchange rates with automated market orders. These, come in various guises. There’s the stop loss order, an automated order placed with a broker below the market to act as a safety net; this ensures the firm receives at least that selected rate even if the exchange rate collapses. Then there’s a limit order, sometimes called a take profit order, which is placed above the current exchange rate in a bid to capture any spikes in the exchange rate that can enhance bottom-line profit if the order is triggered. When used in pairs, these orders are known as OCO – one-cancels-other. Just as the description implies, if one order is triggered the other is cancelled so that firms don’t end up with two contracts.

The other commonly used tool for larger corporates is the option. This grants the right to buy and sell a fixed number of currencies at a predetermined exchange rate by a specific date. If the market moves in a firm’s favour, it can ignore the option and trade at the market rate. If, however, the market moves against the firm, it can exercise the option. They either carry a premium – a few percentage points of the value of the contract – or if not, then there is usually a pair of options packaged together and there will be a potential negative outcome, dependent on the market movement. “Options,” in Johnson’s view “should be treated with genuine suspicion until you fully understand the catches or the full implications of potential downsides.”

But no matter the tools to be used, Foster recommends that firms “put together as detailed a forecast as possible of their expected requirements and then send this over to a currency specialist. They can then conduct a risk assessment which covers several factors such as profit margins, a client’s ability to change price, budget rates, and payment terms, etc”. Once completed, the client will be provided with policy that will allow them to better formulate their currency plan.

DIY or employ a specialist?

With the tools outlined, some think that they can take bull by the horns and do the job themselves. However, Johnson urges caution. In his view, “monitoring the market is simple enough but the problem is the amount of information online, which can be overwhelming”.

Further, the number of opinions available are countless and often conflict. But for him, that’s essential because, “if there were no conflicting opinions, there would be no market... when one person buys another sells and both believe they are being astute”, Also, the volume of information varies according to the prominence of the currency. Put simply, a specialist will have a greater overview of the markets as well as having a better understanding of the ways in which firms can manage transactions, limit risk and protect against unexpected events.

Foster takes a different approach and notes the need to have security of funds as it “is paramount to any business.” He says that it is imperative that the chosen specialist adheres to all the required regulations and, preferably, has been established for at least five years. He recommends “ensuring there is some synergy between the two businesses as brokerages specialise in different areas... a good relationship with your account dealer is key – you will want to feel confident your funds are being managed correctly and efficiently”.

So, with the need to engage a specialist, how should one be chosen? For many, a recommendation is the route that they choose. But if that isn’t possible, then Johnson recommends looking at how the specialist is regulated: “The FCA has a number of categories of regulation. Authorised Payment Institutions and E-Money firms are required to segregate client funds and have a specified level of capital adequacy. Alternatively, check that the specialist is on the Register of Payment Institutions.”

And then there are brokers that can trade in options; Johnson says they are regulated as investment houses and face very tight restrictions.

All firms in these categories are under https://register.fca.org.uk/s/ (we’ve included the weblink as it’s not easy to find).

Fundamentally, Johnson’s advice is that “if you are seeking a fully online offering, you will have to be guided by testimonials and rating companies such as Feefo as well as the company’s website. 

Costs

With an eye to the cost of currency mitigation, Foster says that pricing may differ according to the required currency trade – a spot payment of sterling into euros, for example will differ from a year-long forward contract of dollars into sterling. However, he adds that “most brokerages earn their commission through the rate of exchange they are able to achieve themselves and the one offered to the client.”

Johnson confirms that costs depend on the tool deployed: “With spot contracts, the only cost might be the TT fee for moving your funds, but forward trades usually require some form of upfront deposit, called a margin.” However, he reassures by saying that this is a part payment, so is not really a cost. Importantly, though, he warns that “if the exchange rate moves significantly whilst the position is still awaiting settlement, you may be ‘margin called’. In this case, the broker will ask for further part payment to provide protection for them against default”.

As for options, Johnson says that they can be utilised with no upfront cost, but the potential downside needs to be fully understood in these cases. But if there is a cost, he says that will be charged as a fee for entering the option into the market, known as a premium: “The amount of the fee will depend on the size of the option, the volatility in the currency pair involved and the time between the booking and expiry date of the option. This premium can be anything between 0.5% and 4% depending on the variables.

Foster offers, ultimately, very clear advice: “Protect the budget rate. Nobody can reliably predict exchange rate movements and a good rate today may end up being a bad rate tomorrow.”

Other tools

Beyond using the markets, payments can also be sent and received via a company’s own foreign currency accounts. In fact, Johnson sees companies find flexibility in currency accounts: “Especially so if they have receipts as well as expenses in particular currencies.” An example he gives is dollar receipts being used to make dollar payments without incurring any exchange rate spreads. And the dollars can be exchanged directly into euros to pay euro invoices without having to convert between dollars and sterling before converting again into euro. Another benefit of currency accounts that Johnson highlights is that “they can be topped up when exchange rates are attractive without the need for forward contracts or options.”

And Foster agrees, noting that “firms operating only a sterling account are open to enormous margins being charged by banks for receiving non-sterling funds. By holding additional currency accounts, these funds can then be deposited and converted at a far better rate of exchange.” He adds that these accounts can be opened with a broker (as well as a bank).

In summary

Currency management isn’t necessarily the most important consideration for a board, but it should be on the agenda for any business that trades overseas. With-razor thin margins, a minor swing in the value of a currency can have a disproportionate effect. 

Examples of currency protection

From Halo Financial

David Johnson tells of a UK-based electrical goods importer which “had a fantastic financial controller with whom we had worked with for nearly a decade”.

In overview, after some consultation and with Halo’s experience, she adopted a strategy of covering her forward requirements when rates were above her costed price: “We worked with her to set her costed price at the start of each of their financial years, setting the level below predicted ranges based on the charts of the sterling/euro rate. She rarely took on more than six months’ worth of cover for her needs.”

This process worked well for the controller for the time Halo had been working with her. But as Johnson explains, things changed when her company was taken over by a Dutch supplier and all treasury processes were moved to Holland. He says: “Their procedures were far less structured, and they started to report losses on foreign exchange. The UK financial controller pleaded with them to allow her to return to her preferred processes and after nearly a year they relented.” Within three months, Johnson says that they had recovered their pattern of risk management and stemmed the losses.

From Central FX

At the end of 2019, Tom Foster says that “the pound was performing relatively well across the board, and companies that were more organised were able to forward buy and secure some of their 2020 forecasted exposures.”

He refers next to the emergence of Covid-19, where “currency markets experienced enormous volatility and the value of the pound sunk”. He says that “whilst the deprecation of sterling was felt by everyone, firms that had a clear strategy were afforded time and protection to consider their options”. He adds that “companies that had done nothing, often panicked, and typically overbought at a poor rate. Fast forward six months and the initial easing of lockdown measures, the pound started to recover, and prepared firms were able to take advantage of this having limited the impact of their profit margins and budget rates”. Those that didn’t were sometimes left with large sums of currency secured at unattractive rates that needed paying for.