With foreign exchange (FX) markets changing every second of the day, currency volatility is an important risk for corporates in the professional services sector to manage. Fortunately, there are certain proactive steps companies in this sector can take to minimise the impact of currency volatility on their bottom line.
1. Understanding your risk exposure
To successfully manage your FX risk, you need to understand your exposures across the whole firm. Quantitative analysis such as Value at Risk (VAR), is a statistical technique used to measure and quantify the level of financial risk a professional services firm faces over a specific time frame, including how different exposures may interact with each other in a risk portfolio. Once these currency complexities are understood, businesses can select the financial tools most relevant to their circumstances.
2. Delving into the hedging toolbox
Hedging instruments are the tools that help mitigate or minimise currency risk. While natural hedging - where a company matches the currencies it buys into those that it trades in - is a good approach, in practice it is hard to get close to a 100% balance between these two sides of the business. This is where hedging tools, such as forward contracts, come in.
A forward contract is struck between two entities to buy or sell a specified amount of a currency at an agreed rate of exchange at a future date. Forwards are particularly useful for companies that know they need a specified amount of currency for payment at a certain time in the future and want to negate currency volatility that could occur before that time.
Window forwards are particularly useful because of their inherent flexibility. This type of forward contract purchases or sells foreign currency priced from today’s exchange rate for delivery on or before a specific date in the future. Window forward transactions may involve several payments as long as the whole amount is delivered by the settlement date.
3. Reassess sourcing
A longer-term option to negate currency volatility is to look at the countries the business sources from. This could include looking to source from markets that you are selling to, which could enhance natural hedging, or simply looking to new markets that are either close to home or cheaper. Another option is to develop multiple sourcing relationships in various regions. This allows businesses to switch to the most stable currency exchange rate in their network at any time, proactively heading off possible FX volatility.
American Express can offer support on both forward contracts and natural hedging solutions. To find out more about how these solutions can support your business click here.