Over time the global volume of international trade has increased. The UK has been very active in this trend with an increasing number of small and medium-sized enterprises (SMEs) from the UK choosing to become importers and exporters, trading between currency zones. While being able to do business in foreign currencies brings good opportunities for growth, the problem of dealing with exchange rate volatility has become increasingly recognised.
Any business which trades in foreign currencies is put at risk by exchange rate changes. Changes in the exchange rate can cause importers to face higher costs than planned and, for exporters, profits can be reduced or completely wiped out.
Commonly, companies are at risk of losing money where there is a delay in time between an exchange being agreed to and payment actually being made. For example, a company that exports goods to Europe may agree to a sale in euros which they expect to return them a certain amount of profit when it is converted back into pounds. However, by the time payment is actually received the exchange rate may have changed, making the euro weaker against the pound. The amount that the company receives in euros will convert to less in pounds than anticipated, and profits will be hit.
The risk is the same for importers with costs being at risk of being higher than expected. The risk of a company losing money to exchange rate changes is known as currency risk and where money is lost as a result, this is known as currency loss.
As well as causing companies to lose money, currency risk makes it difficult for businesses to plan operations. What many companies are most in need of, when they trade in foreign currencies, is certainty in terms of what outgoings and incomings will be. Changing exchange rates bring uncertainty and this can make it hard for a business to run operations smoothly.
Small and medium-sized enterprises, which make up 99% of all businesses in the UK, suffer disproportionately from exchange rate changes. While bigger businesses have been able to effectively tackle the problem for some time, SMEs have struggled to do so. Traditionally the process of tackling the problem has been so complicated, time-consuming, and expensive that often only the biggest businesses have been able to do it.
A report issued by Bibby Financial Services in 2017 found that….
The average currency loss for SMEs in the UK that trade in foreign currencies is £70,000
This may sound like a surprising figure, but the extent to which exchange rates fluctuate and the impact that this has on trade is bigger than many people expect. Other surveys have found similar results and many organisations believe that exchange rate fluctuations are the biggest problem facing UK-based SMEs that trade in foreign currencies.
Bibby Financial Services found that….
51% of SMEs that import and 34% which export say that currency volatility is the biggest challenge they face
Only 2% of SMEs protect themselves from currency risk. This compares to 92% of Fortune 500 companies
In recent years people have become more aware of how serious the problem is.
Between 2005 and 2017, the United Nations reported that international trade increased from $12.5 trillion to $22.5 trillion. The number of businesses that now take advantage of the opportunity to trade between currency zones has increased. On top of this, the trend of currency volatility that followed the Brexit vote has made trading in foreign currencies particularly challenging in recent years.
As more and more companies choose to trade in foreign currencies and as the impact of exchange rate changes increases, more and more companies are seeking help. This has caused an increased recognition of the problem, with many organisations highlighting the need that SMEs have for ways to deal with currency risk.
As we already said, traditionally, mainly only the biggest businesses have been able to tackle the problem of currency risk. They have done this by hedging forex (FX) transactions in a variety of ways.
The cost and time investment that has come with FX hedging, on top of the perceived complicatedness of the approaches which are available, has meant that usually, only the biggest businesses have done anything. However, nowadays, more SMEs are looking for ways to carry out FX hedging and more providers of services are looking to provide FX hedging tools to SMEs.
Bound is one company that exists to bring FX hedging to ordinary businesses and to stop it from being something that is only available to the biggest companies. To this end, we provide easy-to-use FX hedging tools on our platform which any business can quickly use to bring certainty to their international trades. As well as providing tools we also work with complete transparency and do everything we can to make FX hedging easy to understand.
FX hedging is not complicated and is not something that only the biggest businesses should consider. Every business which trades in foreign currencies should be able to hedge its transactions and make sure that its profits are protected and that costs do not rise unexpectedly.
Two commonly used FX hedging tools, which are available on the Bound platform, are forward trades and option trades. Here’s how they work.
With a forward trade, a company that is trading in a foreign currency will agree to set an exchange rate with Bound for a future date. This completely avoids the risk of exchange rates changing in the meantime and either hitting profits or increasing costs.
With a forward trade, a company can agree to sales or purchases in foreign currencies which will be settled at a future date. Rather than facing the risk of exchange rates changing before the deal is settled, the company will be able to rely on its forward trade. The forward trade fixes the exchange rate that the company receives when the payment is made.
Forward trades are a commonly used way of hedging FX transactions. They allow businesses to operate with complete certainty about what exchange rate they will receive when transactions in foreign currencies are made.
Option trades are similar to forward trades except that a company has the option of whether or not they actually use the trade. Whereas with a forward trade there is a commitment to exchange currency, with an option trade there is no commitment. This means that a company with an option trade can back out of the option trade if exchange rates move favourably. Where exchange rates move favourably a company can benefit from the situation by trading at the current exchange rate (take a ‘spot’ trade), which is higher than what is set in the option trade.
For sales or purchases made in foreign currencies at future dates, option trades provide a guaranteed minimum exchange rate. This is in much the same way as a forward trade. With the option of taking a minimum pre-agreed exchange rate, a company can operate with complete certainty that it will receive at least a minimum exchange rate. On top of this, if exchange rates move favourably, a company can take advantage of the situation and use the exchange rate change to either increase profits or reduce costs.
The availability of FX hedging tools to SMEs is a relatively recent change. As such, few SMEs are aware that it is possible to hedge their transactions. Currently, there has been a low uptake of FX hedging tools by SMEs that trade in foreign currencies. The 2017 Bibby Financial Services study that we mentioned earlier found that….
Almost 90% of SMEs that trade in foreign currencies do so just with spot trades. Only 28% use forward contracts and even less use option contracts at 7%
The extent to which exchange rate volatility has affected UK-based SMEs has increased in recent years as more and more businesses have begun trading in foreign currencies and as exchange rates have become more unpredictable. SMEs have suffered large losses and have been unable to protect themselves effectively. What is needed is simple ways for SMEs to handle transactions they make in foreign currencies.
Many SMEs which trade internationally will find that they can benefit from FX hedging tools like forward trades and option trades. The services provided by companies like Bound are now more accessible and easier to use than before, meaning that SMEs can benefit from them and not just the biggest businesses.