Irish export businesses must be dynamic about currency risk, writes Barry O’Neill, managing partner of Clear Treasury.
Ireland’s exporters are becoming more dynamic – trade deals are being hit from Jakarta to Johannesburg. Irish companies are fast-becoming global players, and even away from the ISEQ titans, mid-sized companies are developing more complicated streams of revenues, as they develop global trade portfolios.
Irish private business spurned on by government initiatives are making waves in international markets which can now be buoyed by a cheap euro. However, for businesses, the increased nature of international trade has meant that they are required, often on a daily basis, to deal in multiple currencies, often involving large amounts of money. For these businesses, the rate of exchange is an important consideration and can in some instances, if not managed correctly, be the difference between success and failure.
The euro currency has been caught in a perfect storm. The Eurozone crisis aggravated a perpetual slide in the euro against a host of major currencies. This was then followed by a surge in demand for the single currency when the ECB’s president, Mario Draghi promised to “do whatever it takes” to save the Euro. The result was a surge in demand for euro-denominated assets which saw EUR/ USD rise 16% from July 2012 to May 2014. Now the ECB has been forced to act to stimulate a fragile recovery, while the UK and US are looking to exit their easing policies.
Hence we have seen, ECB chief, Mario Draghi actively weaken the euro by taking a razor to ECB deposit rates. The euro was dealt another blow by the announcement of further ECB liquidity measures. The dovish Mr Draghi and the ECB’s actions have left the single currency at fresh lows against the dollar and sterling.
Of course, this is all great news for Irish export-led businesses. Economies around the world with strong currencies substitute local product for relatively cheap euro-denominated imports – hence, we are likely to see an upsurge in Irish exports as the euro continues to freefall. But as in life, markets are always in a constant state of flux. Irish businesses must see foreign currency as a zero-sum situation. ‘Good’ news for sterling or euro means ‘bad’ news for another currency and vice versa. They must also recognise the volatile nature of currencies ,and while, it looks like the ECB will look to keep the euro cheap, a long-term trajectory of a falling euro is by no means a certainty. The lesson for many export-driven economies has been that currencies endure value cycles – just as a rise is precipitated, so will its fall.
Diversifying your business on the world stage is important for growth but there are inherent risks – and currency exposure is a potential major pitfall. Currency movements are notoriously volatile and can be painfully acute – the value of the euro has fallen against sterling as much as 9% in the past 10 months; it just depends on what side of the trade you happen to be on.
It is critical that companies have full visibility of their overall exposure to currency so that they can mitigate balance sheet risk. Companies with overseas trading partners will soon build up a tangled web of currency liabilities or revenues, so managing these accounts and recognising the current value of future payments or receipts is extremely important. If a currency fluctuates significantly downwards, it can have a devastating effect on a company’s finances
It is clear that possessing a clearer view of currency exposures ensures companies are in a better position to actively manage their risk. We are all now part of global economic community than can be infected from time-to-time with contagion – currency volatility can often be a symptom of a contagion. The good news is that there are preventive measures that companies can take. Since the start of the financial crisis in 2008, we’ve seen an increasing number doing just that.
Currency volatility has prompted a surge in demand in the use of forward contracts, options and other hedging tactics by our clients over the last 5 years. Irish companies are reacting to increased volatility, and are gaining a better understanding of currency risk. They realise they must have more tools at their disposal so that they can protect their margins. The basic forward contract remains the most popular approach, locking in a rate of exchange for a future payment. It is a basic but sensible strategy for businesses with scheduled payments or receipts. However the evolution of structured hedging products also allows our client to benefit from favourable moves in the currency markets, while ensuring their FX risks are also fully protected.
What is also spurring Irish business to manage more effectively their currency risk is a paradigm shift in terms of providers. Once, Irish banks had the monopoly on foreign exchange. Their fees reflected their phlegmatic approach, where high fees and generic service underlined their lack of understanding of their clients’ needs and unwillingness to get to know their businesses. Now more nimble competitors have entered, unencumbered by large debts and overheads they can afford transparent and affordable consultation that addressees and mitigates balance sheet risk.
Ireland will always be an export-led economy and it is important for businesses to make hay when the sun shines. However, to ignore the potential pitfalls of currency movements is to ignore the very nature of financial markets – and, worst of all, imperil a balance sheet of an otherwise healthy business. Fortunately, Irish businesses now have plenty of options to manage that exposure, and plan effectively for the future.
Barry O’Neill is managing partner of Clear Treasury, a foreign exchange and treasury risk management company with offices in Dublin and London.
Previously, O’Neill was a senior broker at currency specialist Voltrex and has also held positions as a foreign exchange trader at Anglo Irish Bank and as a broker at HiFx, one of the UK’s leading independent currency exchange experts.