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As the United
Kingdom’s (UK’s) departure date from the European
Union (EU) becomes more uncertain and delayed,
businesses and investors are becoming increasingly
anxious. CFOs, corporate treasurers and business
owners are allocating significant time and resources
planning for a worst-case ‘Hard Brexit’ scenario
without understanding the full extent of what this
worst-case scenario fully entails.
As future trade relations with the EU have been
unclear since the initial Brexit referendum in 2016
and remain unclear today, key economic indicators
such as employment, inflation, trade and growth
remain unsettled.
Brexit has featured as the main topic of discussion
for media outlets and news reports across Europe and
the globe as a result of the potential ripple
effects stemming from the UK’s exit from the EU
almost five decades after it joined the then
European Economic Community (EEC) in 1973. Yet the
more discourse that surrounds the protracted divorce
proceedings, the less confidence the media seemingly
has in it.
As large multinational corporates all the way down
to Micro businesses await with bated breath
effectively expecting the unexpected, a key question
that arises is, ‘are hedging ratios for corporates
as high as they should be given the level of
potential volatility?’
In this challenging environment, UK businesses have
had to cope with a volatile Great British Pound (GBP).
Leading up the initial Brexit referendum in 2016,
the GBP volatility index*, or otherwise known as the
‘fear index’, jumped by an astonishing 180 percent.
In the latter part of 2017 the volatility index fell
by four percent and as of H2 2019 the index is
firmly higher by up to 40 percent.
Recent currency forecasts conducted by East &
Partners (East) in H2 2019 reveal that enterprises
with £1 - £5 million annual revenue hold a
distinctly bullish outlook for the value of the GBP
against key currency pairs for the six months to
June 2020. In contrast, larger sized corporates
project the GBP to fall by a considerable margin.
The surprisingly high level of variance in six
monthly forecasts between SME and middle market
segments is a defining characteristic of East’s
global currency forecast analysis, capturing rolling
six monthly forecasts across a basket of major
currency pairs by Australian, Asia, European and
North American importers and exporters.
Historically, East
has found larger businesses to be more accurate in
forecasting currency exchange rates within a
six-mouth interval compared to smaller firms.
Therefore, it seems as if the GBP recovery is set to
be short lived. Increased currency volatility can
have profound effects on corporate supply chain
operations as imports become more expensive.
Nevertheless, as the UK faces a general election on
the 12th of December 2019 and an extended Brexit
deadline on the 31st of January 2020, without a
set-in-stone trade agreement with the EU - the UK’s
biggest trading partner - GBP price action will
become highly volatile.
Due to this uncertainty more businesses in the UK
are engaging with risk management products such as
FX Options and Forward FX. Recently released data
from East & Partners long running Global Business FX
research programs highlight just how much businesses
of all sizes are ensuring that their downside
currency risk is mitigated.
Since 2016 FX Options penetration has increased by
11.8 percent for Microbusinesses and 19.6 percent
for SMEs while FX Forward penetration has expanded
by 14.8 percent and 24.2 percent respectively. Lower
Corporates have geared up regular use of both FX
Options and Forwards by 14 percent. As smaller
businesses level of engagement with appropriate FX
risk management solutions proceeds at a slower rate
relative to larger internationally trading
enterprises, they run a greater risk of potentially
highly damaging FX losses.
Nevertheless, as more
businesses engage with risk management products and
transition from infrequent to regular usage, the
proportion of their hedged FX turnover has also been
characterised by a discernible upward trend market
wide.
This data-based insight infers that UK firms are
deciding to hedge a higher proportion of their FX
turnover on a six-month interval irrespective of
their prevailing trade profile. Both importers and
exporters are turning to their bank, and
increasingly non-bank FX providers, for advice and
support in managing heightened FX price volatility.
Both banks and non-bank FX providers will be tested
in the event of a sudden correction in the GBP,
leading many corporates to review their FX risk
management relationships. Following the initial 2016
Brexit referendum, World First closed its FX Options
trading desk in 2017, transferring staff to other
divisions of the group. East & Partners research
reveals although Monex and Western Union are the
largest UK non-bank FX Options providers,
relationship share growth has been constrained in
the face of resurgent growth by incumbent majors
including HSBC, Citi, Barclays and Bank of America.
Both Monex and Western Union have had greater
success competing for new Forward FX relationships
among Lower Corporates and emerged as popular
secondary Forward FX providers noting a lack of
usage for both Options or Forwards by
Microbusinesses and SMEs.
Small business owners, whether importer, exporter or
both, are hedging less than 50 percent of their
total FX turnover despite costly hedging losses
incurred in the wake of the ten percent GBP/USD
depreciation in 2016 to 30-year lows in the wake of
the Brexit vote.
East & Partners research reveals how vulnerable
smaller businesses are within the current political
and economic climate permeating financial markets.
Despite significant regulatory and compliance entry
costs, there is a clear opportunity for non-bank FX
providers to engage risk management products and
tools that small businesses require in order to
minimise their risk profile within their trade and
supply chain operations – a section that has been
traditionally neglected by banks. After all, today’s
small businesses are tomorrow’s institutional
enterprises.
* - CBOE/CME FX
British Pond Volatility (BPVIX), Investing.com
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