Andy Hart, Head of Investec’s Asset Finance Group and James Arnold, Head of Investec Corporate Treasury, discuss how to manage foreign exchange risk after Brexit
With the sterling having dropped so sharply after the UK’s vote to leave the EU, the risks associated with foreign exchange fluctuations have moved centre-stage and are getting a lot more attention at board level.
Currency hedging can have an impact on the bottom line during periods of volatility and executive boards are often not aware of how big this impact can be, but are increasingly taking not just an interest but responsibility.
Some boards want to put specific hedging strategies in place, having taken an ad hoc approach previously, while others simply want to formulate a policy, determining the process through which they react to the changing market, down to who has to sign off on new hedges.
These are important questions when adverse moves can have a material impact on profitability, and FDs and CFOs should gain a shared decision with their board on this.
Changing accounting standards
There are also a lot of conversations taking place on the effect of changing accounting standards, which have moved derivatives transactions on to corporate balance sheets with potentially damaging consequences.
When a company is ‘underwater’ on its derivatives – because the market has moved in such a way as to make the original hedge worthless – it has an impact on their accounted earnings, as opposed to their true cash earnings.
This is a big problem for companies whose accounts are used by suppliers to assess creditworthiness, some of which are tempted not to hedge as a result – itself a risky move and one that is increasingly on senior financial officers’ radar.
Managing cash flow
Hedging is not the only way to introduce a bit of certainty in an unpredictable market environment.
Certainty of cost can provide a tremendous boost to business confidence in volatile times and using finance to buy new business assets such as fork lift trucks, photocopiers or even office fit outs, can provide the business with fixed periodic payments.
This allows companies to grow with better forecasting and without eroding their cash balances, using their overdraft or taking out costly and inflexible traditional loans.
This is especially important at a time when businesses want to assure customers, suppliers and investors that their long-term prospects are good despite the changing environment.
Even in volatile periods, companies need to adapt to retain and increase client share, and that often means investing in the business.
There may be an excellent business case for that vital piece of equipment allowing a firm to expand production, or the expanded vehicle fleet to reach more customers, but FDs and CFOs could quite reasonably argue that the uncertainties of Brexit make this a difficult time to justify major investment, especially if it requires a major cash commitment or costly loan.
Asset finance can provide one possible solution, distributing payments across a manageable timeframe.
This isn’t just for big, transformational acquisitions. Business-critical expenses such as an up-to-date IT system are just as applicable, and neither is it limited to physical investments.Businesses have other major costs to meet, as the recent controversy on business rates reminds us.
The budget may have been unexciting, but it’s clear that the broader business environment will be anything but boring as we enter the negotiation phase during our departure from the EU.
FDs and CFOs can’t stop the inevitable volatility from happening, but by taking a strategic approach they can manage their risks and even keep growing as the politicians do their talking.
Andy Hart is Head of the Investec Asset Finance Group and James Arnold is Head of Investec Corporate Treasury