Why hedging is important

February 6, 2018

2017 proved an exceptionally volatile year in the foreign exchange market, highlighting the considerable benefits to businesses and individuals of mitigating risk through hedging currency exposure. Hedging will allow you to:

 

  • Take advantage of today’s rates for a period of up to six years

  • Guarantee the value of future revenues and expenditure

  • Remove concerns created by today’s turbulent currency markets

  • Remove the need to buy currency before it is required

  • Flexibility to choose whether to buy at market rates or drawdown from your contract depending on whether rates are in your favour or not at the point of need

 

For any business operating on tight margins, hedging provides insurance against margin erosion or even a move into negative territory. Importers paying in USD will have seen a 13% increase in costs simply from currency exposure since the beginning of the year. A sensible hedging strategy can protect against this type of risk.

Sterling in particular has experienced a very unpredictable few months, suffering from its largest ever one-day depreciation against the US Dollar following the shock Brexit vote in June. The currency has plunged by almost 20% since referendum day, falling to a 31 year low against the US Dollar (Figure 1) and its weakest position versus the Euro since 2010.

You only need to look at the path sterling has taken in 2016 to see how significantly your business could be adversely affected if you are not locking in exchange rates.

The ability to lock in exchange rates at a more favourable rate can help protect margins by alleviating downside risks from adverse currency movements.

 

Figure 1: GBP/USD (January ’16 – October ’16)
Source: Thomson Reuters Datastream Date: 18/10/2016


The political and economic uncertainty created following the referendum, combined with the aggressive monetary policy stances of many of the world’s major central banks, has ensured the period of large and unpredictable swings in the currency market are likely to persist for the foreseeable future.

     

     

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