With a minority UK government sending sterling south, this blog explains why the newly-published FX Code puts a global corporate’s risk management practices under the microscope.
Where did that come from? You have to go back over 20 years to the days of John Major for the last time a minority government was left clinging onto the reins of power in the UK. But after a comparative period of calm post the Brexit and Trump storms, perhaps we were overdue another political tornado. The trouble is that away from the Westminster soap opera, corporates across the world are, like the electorate, left in limbo.
This last bolt from the blue, or should that be red, has hit the currency markets – with sterling falling by as much as 2.34% to $1.2635 against the dollar. As the Tories and Democratic Unionist Party (DUP) get their feet underneath the cabinet table, further currency ups and downs are inevitable.
Unfortunately, history tells us that frequent and unexpected bouts of volatility paves the way for currency manipulation. Take the alleged case of exchange rate tampering behind the Turkish lira’s (TRY) volatility back in January. In addition, no firm wants to find itself embroiled in a currency scandal hot on the on the heels of the newly-issued Foreign Exchange (FX) Code of Conduct – a set of guidelines encouraging best practice across currency markets.
New emphasis on hedging
For corporates looking to proactively manage their risk exposure to sterling following last week’s UK election, an early assessment of what the Code really means for their business should be top of the agenda. On initial reading, it is hard to see what is not to like. After all, what group treasurer wouldn’t want greater market transparency to help reduce the costs of purchasing rates?
Also, a greater insight into wholesale FX trading should, by definition, give them more data to inform hedging decisions. Yet while this sounds great in principle, the Code is not a specific piece of legislation and there is no obligation for the interbank market to follow it.
It’s too early to tell whether the Code will prove to be successful, but either way, it will not happen overnight. Regardless of steps the institutional FX market takes, corporates can ill afford to wait and see. The combination of the Code’s risk management principles and the currency volatility that could dog a minority government means that corporates need to put an even greater emphasis on hedging their sterling positions in the short-term.
Group treasury teams only have to look back at how the pound plummeted post-Brexit to recognise the importance of having weekly or even daily views of risk exposure. Therefore, when turning the pages of the FX Code over the coming weeks, the key question treasurers need to be asking themselves is whether their hedging strategy is sufficient.
Nobody is ever completely hedged, but given current political uncertainty and to meet the Code’s risk management requirements, many will need a complete view of their risk exposure in order to make the best possible hedging decisions in the days ahead.