Businesses are being short-changed by the approach of traditional banking to managing currency volatility. Laurent Descout, CEO at Neo, looks at how treasurers are embracing alternative approaches to tackle the risks
In the current financial climate, businesses are having to consider various factors to protect their commercial gains. In particular, rising inflation and the high volatility in currency exchange rates are taking their toll – and businesses which have previously overlooked FX hedging will likely feel the biggest impact.
These businesses, particularly SMEs, are working in an environment where the true costs and potential returns are impacted by fluctuations in currency values. A business which operates on bank margins of say 10%-15%, risks suffering losses even before delivering their goods.
While it is now critical for businesses to ‘lock in’ rates ahead of buying and selling goods and services, there needs to be a better understanding of the importance of FX hedging and managing currency risk. As volatility goes up, the necessity for business to become more ‘hedge’ savvy increases.
The current financial environment has exposed weaknesses within the traditional corporate banking model for businesses needing to manage currency risk. Many businesses find that their bank simply doesn’t provide the right level of education and advice when it comes to FX hedging.
Businesses need support to help them understand how to hedge and the risks of not controlling their margins. This includes knowing the true costs and what the returns will be on each sale. Only then can hedging become an integral part of the business strategy and have a positive impact on the profit and losses.
Technical support from many banks doesn’t offer the hedging knowledge required, which leads to businesses seeking out an international trade specialist. However, even then the support often falls short.
The actual hedging tools that banks do provide are often inadequate – and these tools regularly sit in a separate environment to payments and cash flow. SMEs frequently need to have different bank accounts for different currencies, many of which operate in silos. As a result, they are unable to view their cash flow in real-time and lack full financial visibility across their business.
Some businesses are also still reliant on banks to execute and exchange their currency orders, resulting in long lead times and high commissions.
When it comes to hedging strategies, there are some common approaches available to most businesses. The most popular are buying and selling forwards and options, which involves taking an option on the currency, based on the level of certainty required on the cash flow being hedged.
While there is no “one size fits all” approach, demand is growing for these more vanilla hedging products. They are secure, simple to understand, relatively liquid and easy to unwind if market conditions or risk appetites change.
The percentage of exposure to protect, however, will vary between businesses. Most will hedge up to a few months, but long hedging is quite rare and it’s also standard to not hedge all of the current budget. It is important to be realistic and set short-term targets, focusing on areas which are likely to affect the business the most and build from there. Hedging strategies can evolve and expand so it should always be in review once implemented.
With a strategy in place, businesses need the right tools and it is no longer feasible nor sustainable for businesses to rely on spreadsheets for their forecasting, cash flow and accounts, and stock management. What businesses need is an alternative approach – a way to manage cash flow and hedging in one integrated environment. They need to be able to book their hedge and, when it settles, decide where it goes – all in a smooth and efficient process.
Fortunately, recent advancements in fintech mean it is possible to access all the key services needed for a corporate hedging strategy, including automated payments and collections, forecasting tools, FX hedging and risk management.
This includes multi-currency accounts with an IBAN in the company’s name and virtual wallets to hold multiple currencies and organise funds. This allows for receiving or making payments in the same currency as the counterparty, meaning there is no need to hedge or convert it. This improves cash flow as accessing currency becomes immediate.
As FX hedging becomes a top concern amidst today’s market uncertainty, alternative approaches such as these are enabling businesses to make that first crucial step beyond the traditional banking constraints. As a result, they can gain greater oversight of their treasury in real-time and utilise insights to drive faster, better decisions.