How Corporation Tax Changes Increase FX Risk

The Exchequer Chancellor's decision to raise the UK's corporation tax rate could hurt foreign investors, according to Greg Smith, founder of Hawk FX.

"The companies that will be affected are the large ones, the top ten per cent. Disproportionally, these companies have more investors from overseas. These companies are more international, so if there is a noticeable impact on cash flow, then those same companies will be more sensitive to currency risk as a result," he says.

The Chancellor's Announcement to Increase Corporation Tax Rate Company Profits from 19 to 25 Per Cent in 2023

Businesses with profits of £50,000 or less will not have to pay any more tax than they already are, as the Chancellor has announced the creation of a Small Profits Rate that applies to businesses where their turnover is less than £250,000. The total 25 per cent tax rate will only apply to companies with profits of more than £250,000. The current 19 per cent rate will apply to businesses with a turnover of less than £50,000.

According to the Westminster coalition, the corporation rate hike, as part of the government's commitment to reduce the deficit and debt, will increase revenue by an estimated £3.3 billion across the UK. This is estimated to generate an extra £1 billion for the UK.

Some of the leading sectors affected include oil and gas, aerospace, and life sciences, says Smith.

"Many of the oil and gas companies that have been trading at a loss have been using big depreciation allowances to push them into a profit. Companies trading at a loss have been able to carry a lot of their expenses forward and claim them against future profits later when the company becomes profitable. This was a way of allowing them to do that," he notes.

The Chancellor's move may have consequences on foreign investment performance in the UK, believes Paul Titheradge, CEO of Vela.

"The Chancellor's decision will be seen by many as a sideswipe to foreign investors in the UK and a less than credible counter-cyclical measure. Today's Budget is more likely to be seen as a case of we need money, so let's tax business more than anything else," he says.

The increase in the corporation tax rate will lead to a rise in the cost of doing business, which will affect the business transactions and transactions in the UK, says Simon Robinson, director of Dymocks FX.

"Businesses in the UK will have to pay more for their transactions, which means it will be more expensive for foreign investors to use their capital to buy UK assets," he says.

The Effect of the Rise in Corporate Tax Rate to Foreign Exchange Rates

The main impact of the rise in corporate tax rate for foreign exchange rates is that it will harm the capital flow and FX demand, says Titheradge.

"It is important to remember that the UK has more of a floating currency than most developed economies, so it is likely to be influenced by events in the wider European economy to a greater extent than the likes of Germany and Japan," he says.

The impact of the rise in corporate tax rate will depend on how the currency of the UK is going to trade against other currencies, adds Smith.

"If the pound is fairly close to where it is today, then the impact may not be noticeable, but if the pound is trading at a multi-year high against the other major currencies, then there will be a bigger impact," he says.

According to Robinson, the global market is currently experiencing a recovery following the global financial crisis and the global recession. The global economy is expected to continue to grow, even though it is not expected to grow very fast.

Why an FX Risk Management Framework Is Crucial

A strong FX risk management framework is needed to help UK businesses mitigate and manage FX risks, says Smith.

"If they don't have a strong FX risk management framework in place, they will be more exposed to longer-term movements in the currency, which will lead to greater turbulence in the business," he says.

Businesses should consider hedging options to protect their revenues, cautions Titheradge.

"This should include forward hedging to protect against exchange rate volatility and looking at more sophisticated hedging products such as currency swaps," he says.

According to Robinson, businesses will have to assess the impact of future exchange rate movements on their cash flows.

"The impact on the business will depend on the exchange rate movements, so businesses will have to assess whether these changes in exchange rates will affect their cash flows. If it is, then they should consider hedging options to protect against the impact of those currency exposures," he says.

The Importance of a Risk Oversight Committee in Adopting a Risk Management Framework

A risk oversight committee in a UK business, particularly a large corporation, should include senior people and senior management team members, says Titheradge.

"It is important that the committee is not dominated by CFOs and finance directors, but by senior and experienced members of the business, who understand the way business works and know how the business generates revenues," he says.

According to Smith, businesses should have the latest data on the company and its cash flows.

"The key point for businesses to understand is that the risk management framework can't be one-size-fits-all. Not all businesses will be the same, and not all businesses will follow the same strategies. That is why businesses need to have their own risk management strategies to ensure that they are compliant with how they will trade," he says.

Risk Management: Strategies to Mitigate FX Risk

There are several risk management strategies that businesses in the UK can adopt. However, the best ones would be ETF Hedge, Forward Contracts, and Currency Options.

ETF Hedge

ETF Hedge is a trading strategy suitable for investors who would like to hedge their exposure to certain currencies and ongoing currency risk. The ETF Hedge will allow the investor to sell an equal amount of the currency at a specified future date to lock in the current exchange rate and avoid foreign exchange risk.

What Are the Costs of ETF Hedges?

The costs of an ETF Hedge will depend on the length of the ETF Hedge being bought. The longer the ETF Hedge, the higher the investor will have to pay. The current price of the ETF Hedge will depend on the prevailing exchange rate when the ETF Hedge is being purchased. The premium can be calculated using the prevailing price of the ETF Hedge and the strike date as parameters for the calculation. The investor will also have to pay a commission for the ETF Hedge, which is generally within the range of 0.1 to one per cent of the ETF Hedge value.

Why Choose ETF Hedges?

The ETF Hedge is suitable for investors who would like to eliminate the risk of currency fluctuations on the investment of the fund or portfolio. The ETF Hedge is ideal for investors who have investment portfolios that have been exposed to currency market risk. It is also suitable for investors looking for a hedging strategy that will help them protect the value of their investments.

The ETF Hedge has several advantages and benefits that appeal to investors. The ETF Hedge is flexible and can be customised according to the investor's needs. The investor can choose from several ETF Hedge providers and brokers.

The ETF Hedge is relatively cost-effective compared to other hedging strategies and suitable for large and small investors. The ETF Hedge can also be used for hedging both long and short positions. The ETF Hedge is also ideal for investors who have both domestic and non-domestic investments.

Forward Contracts

Forward Contracts are agreements between two counterparties to buy or sell a given asset at a future date. The Forward Contracts are often used to fix the price of foreign exchange to reduce the risk of adverse exchange fluctuations. Some investors will use the Forward Contracts to hedge their exposure to exchange rate risks.

What Are the Costs of Forward Contracts?

Forward Contracts have to be paid for at the time of the purchase, and there are usually penalties for closing out the contract early. The longer the expiry date of the forward contract, the higher the cost of the forward contract. The current cost of the forward contract will be the forward price, which is the price that the investor is willing to pay or sell the foreign exchange.

The future value of the forward contract will depend on the fluctuations in the exchange rate. The cost of the forward contract can be calculated using the forward price of the currency and the strike price.

Why Choose Forward Contracts?

Forward Contracts provide the investor with a way of locking the exchange rate for an investment. This is particularly useful for investors investing in an asset with a longer-term horizon for profit.

Forward Contracts have several advantages that make them a suitable hedging strategy for investors. The Forward Contracts are relatively easy to open, and the investor can choose from several providers. The Forward Contracts are flexible, and the investor can choose the expiry date of the forward contract.

The Forward Contracts are relatively cost-effective compared to other hedging strategies. The Forward Contracts can also be used to hedge both long and short positions. The Forward Contracts are suitable for investors who have both domestic and non-domestic investments.

Currency Options

Currency Options are a type of derivative whose value is based on the price of currencies. They are commonly used as a hedge against adverse exchange rate fluctuations. Currency Options will allow the investor to buy or sell the currency of their choice at a specific future date.

What Are the Costs of Currency Options?

The cost of the currency option will depend on the duration of the option and the strike price. The shorter the period of the currency option, the lower the cost of the currency option. The current cost of the currency option will be the current traded price, but the future value of the currency option will depend on the fluctuations in the exchange rate. The cost of the currency option can be calculated using the current traded price, the strike price, the currency price, and the number of currency options.

Why Choose Currency Options?

Currency Options are a suitable hedging strategy for investors who would like to hedge against adverse exchange rate fluctuations. They are ideal for short-term exposures, which means that they are right to hedge against short-term volatility in the exchange rate.

They can also be used to open up new investment opportunities that previously would not have been available to the investor. They are also cost-effective compared to other hedging strategies.

What is the Difference Between Forward Contracts, ETF Hedges, and Currency Options?

Forward Contracts: A forward contract is an agreement to buy or sell a specific product or currency at a future date. The forward contract will allow the investor to buy or sell the currency of their choice at a particular future date. The forward contract will enable the investor to lock in the exchange rate for an investment.

ETF Hedges: An ETF Hedge is a trading strategy suitable for investors who want to hedge their exposure to certain currencies and ongoing currency risk. The ETF Hedge will allow the investor to sell an equal amount of the currency at a specified future date to lock in the current exchange rate and avoid foreign exchange risk.

Currency Options: A currency option is a derivative whose value is based on the price of currencies. They are commonly used as a hedge against adverse exchange rate fluctuations. Currency options will allow the investor to buy or sell the currency of their choices at a specific future date.

Conclusion

FX risk is an everyday occurrence for businesses that operate in a global economy. The risk is particularly high for companies that invest in foreign currencies. However, the risk can be mitigated if businesses have the right strategies. An FX risk management framework will help the entity reduce the amount of FX risk that could impact the business.

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