The bad news? There is a real and potentially significant exchange rate risk for companies doing business outside the eurozone. The good news? There are solutions for managing that risk. Ivo Mertens, Senior FX Advisor at our partner iBanFirst, explained a number of these solutions in a webinar.
Unfortunately, there is no getting away from it: every company that imports or exports from or to countries outside the eurozone inevitably has to deal with foreign currencies, and therefore with currency risks. “These risks can be very obvious, but can just as easily be hidden somewhere,” says Ivo Mertens. “For example, as an importer you may pay your invoices in euros, but that doesn’t prevent your suppliers from taking the exchange rate into account when setting their prices.”
“Likewise, if you have valuable assets such as shares or debt denominated in a foreign currency, you run a certain exchange rate risk,” Ivo Mertens continues. “And then there are the risks that are more or less inherent in the business of certain companies or sectors. Think, for example, of companies that use a lot of oil products: the price of petroleum is expressed in dollars, so indirectly that also entails an exchange rate risk.”
One currency is not the other
The exchange rate risks for those doing business outside the eurozone are not only real, they can be quite substantial also. It is not for nothing that the forex market is known as the largest and most liquid of all financial markets, larger even than the stock and commodity markets. “To give you an idea, the forex market handles in about five days the total volume that all stock markets together trade in one year. In other words, a single working week in the forex market represents a full year in the global equity markets,” Ivo Mertens sums up.
One currency is not the same as another, of course, and the exchange risk differs from one currency to another. The exchange rate fluctuations of the euro and the dollar, for example, are small compared to the volatility of more exotic currencies, such as the South African rand or the Turkish lira. “The latter lost half of its value at one point, just like that. We are then talking about risks that are of a different order than with the more common currencies, such as the US dollar and the pound sterling.” However, even in transactions with these more stable currencies, you can see your entire profit margin go up in smoke as a result of exchange rate movements if you do not take the right precautions.
No empty predictions, but scenario analyses
The fact that forex is a very large and liquid market also means that it is not always easy to understand. And predicting trends or movements on that market is an even greater challenge, if at all possible. Yet it is precisely in this area that Ivo Mertens and his colleagues are increasingly successful. “The movements of certain currencies in relation to each other entail a certain exchange rate risk,” he explains. “That depends on the currencies in question, as I mentioned, but also on the volumes a company exports or imports and on the duration of the exposure to the risk in question, for instance.”
“Needless to say, we can never predict with absolute certainty how such a currency pair will move in the future,” Ivo Mertens admits. “But we can draw up a number of possible scenarios and calculate their statistical probability within a certain expectation interval. We can then rely on those approximation calculations eventually to propose a number of concrete solutions to our clients after such a scenario analysis.”
For solutions do exist. “Companies can hedge themselves perfectly against most currency risks. Even the indirect currency risks, which I referred to earlier, can be hedged these days. It simply takes a little more analysis and study to map these risks with precision as well. Once that has been done, we can provide an adapted, more or less dynamic solution that is actually tailored to your needs, your vision and, above all, your appetite for risk,” concludes Ivo Mertens.