While the UK government waits to see whether its U-turn on its proposal to axe the 45% marginal rate of income tax paid by those who earn more than £150,000 is enough to stop the fall in sterling, market bets against the currency over the next year have risen to a record high.
But in the meantime, growing uncertainty over the pound, as well as the surging value of the US dollar, has intensified pressure on corporates to adapt their hedging practices to protect their bottom line, according to FX specialist MillTechFX.
The company is seeing corporates move away from exotic products, back towards familiar, simpler products such as forwards, which are much easier to unwind. As Eric Huttman, CEO at MillTechFX, says: “Currency volatility has become one of the dominant macroeconomic trends of the year. The dollar has surged to 20-year highs while the pound and euro have slumped to 50- and 20-year lows respectively. The pressure on corporates… is intensifying as they adapt to this new environment.
“During calmer times pre-COVID-19, some corporates moved towards more exotic products. Now they appear to be reverting back towards the more straightforward linear products such as forwards, which are more liquid and easier for corporates to unwind should the market move against them.”
MillTechFX also reports corporates shifting to shorter tenors – the length of time remaining before a financial contract expires – that are now increasingly below six months to maintain a level of flexibility.
“Instead of locking in rates for 12 months or more, corporates are increasingly using more shorter-dated forwards with tenors below six months, which are then rolled at maturity to maintain the hedge,” Huttman says. “This helps to provide firms with more flexibility should they need to adjust their exposure.”
The company is also seeing corporates increase hedging ratios to protect more of their exposure. “While there will always be some that don’t hedge their FX risk at all, those that haven’t are now considering do so given recent market volatility and negative currency impacts,” Huttman says.
“Those corporates that already had formal hedging programmes in place are now increasing their hedge ratios to protect their bottom lines.”
The report comes as payment fintech Moneycorp suggests a number of ways in which corporates can mitigate the impact of FX exposure:
Transparency on FX costs: The World Bank says the average transaction cost of sending $200 globally is 6%. For larger business transactions, it becomes apparent why it is important to conduct a Transaction Cost Analysis. With the current market volatility, it is important to know how much each transaction will actually cost. Companies can take advantage of quantified FX costs to audit and adjust their FX risk management practices regularly.
Make use of forward contracts: Forward contracts, either fixed or dynamic, can be customised to allow companies to lock an exchange rate for a future overseas payment. With a forward contract, companies can fix the cost of their international business payments, allowing them to plan ahead with reassurance and certainty. Forward contracts are also a good option for those looking to capitalise on the likely rate hikes from the upcoming US Federal Reserve meeting.
Utilising currency swaps: Currency swaps are an agreement between two counterparties to exchange financial instruments, cash flows or payments at multiple intervals. Knowing that most central banks are looking to raise rates to combat inflation, it is a good time to use currency swaps to gain access to lower foreign interest rates.
Philip Smith is editor of The Treasurer