Corporate Finance » Western Union: Corporates need better risk management processes as GBP volatility forecasted

UK businesses involved in imports and exports must pay greater attention to currency fluctuations as the pound (GBP) could continue to face increased levels of volatility, according to Western Union Business Solutions director of hedging UK, Alex Lawson.

“Over the past few years, because of the Brexit vote in 2016, all the subsequent political shenanigans and the pandemic, we’ve seen some dramatic fluctuations which have reminded people of the importance of risk management when it comes to foreign exchange,” Lawson says.

As an illustration, in the four years prior to the referendum, on average the GBPUSD rate saw a 10 percent range across a year, but in the four years since the referendum, that has increased to 15 percent. On the day of the referendum result, the pound had dropped eight percent by close of business, but had traded in a 13 percent range on that day alone. Although not on the same scale, there have been similar large intraday swings since then, not least as the reality of the pandemic hit home last March, with GBPUSD dropping more than 12 percent in a week to record lows in the $1.1400’s – a far cry from the former comfort zone between $1.5000 and $1.6000. Against the euro, a similar drop was recorded from above €1.2000 to the €1.0500’s, albeit over a two-week period rather than one.

“As Brexit fades into the background and, we hope, the pandemic passes, such large intraday movements should once again become rare; however, as the UK diverges from Europe we may see an increase in general volatility of the pound, but against the euro in particular as our respective economies become less closely entwined. Although they remain our largest export market, that share has already been falling steadily and trade deals with new markets may accelerate that change.”

Lawson says that for better or for worse, the UK economy may now face different headwinds than the EU as Brexit reduces the symmetry between the two and the UK is forced to look to new markets as frictions increase. For example, data from The Road Haulage Association suggests that trade to the EU reduced by 68 percent in January 2021 compared to January 2020.

“Previously, something that’s good for Europe would also be good for the UK and vice versa. But that may now change. We might see more short-term volatility where the timing of the execution of a transaction for an FD would be a more important consideration.

“Rather than having the luxury of saying, ‘I’ll book my euros at some point this week’, that will change in the future – more so than it has in recent years,” Lawson says.

As a result, corporates can no longer afford to be blasé about currency swings, particularly if they are now trading further afield, Lawson adds.

“This requires the finance department to take a longer-term view on the outlook. Even if your hedging horizon is only three to six months and you don’t expect things to change too much in the near term, your planning process should also now consider the potential impacts of these changes on currency rates over the next three to four years.”

Since the UK formally left the European Union with a thin trade deal on the eve of 2021, GBP has risen against the euro from 1.09 in early December to a high of 1.17 in March this year. Although the recent row over the coronavirus vaccine exports illustrated how fragile the deal between the EU and UK is, the trade agreement has brought greater certainty to markets and in turn, to currency.

“Those who need to sell GBP and buy overseas currencies in general have seen things gradually getting better in recent months,” says Lawson. “It’s easy to think that it’s just going to continue indefinitely but of course, we know it won’t.”

In a cautionary tale, Lawson speaks of one finance head who had gone on holiday during the Brexit referendum without hedging his currency risk against the possibility of a win for the leave camp. On his return, he found his profit margins had been decimated and his services at the company no longer required.

“Whereas before with normal fluctuations you might see a few percent here or there, if that suddenly becomes 10 or 20 percent then, even if you’ve got quite a healthy profit margin, it’s going to take a significant bite out of it.”

To avoid these dangerous scenarios, it is critical that finance teams gain visibility over how currency movements will affect risk, devise a plan to manage the risk with clear objectives, and make sure individual responsibilities are well understood so that you can react quickly to events as they unfold, says Lawson.

“Have you quantified your risk? When do you pull the trigger? Should you lock-in and hedge now, or wait until tomorrow? Do you protect your budget rate, or are you aiming for a more ambitious target rate and is that realistic? Should you look at alternative products that allow some degree of protection but also the degree of participation in favourable moments as well?

“That’s the kind of thing Western Union can help you with, as well as road-testing and sense checking your risk management strategy.”