In recent weeks, war erupted in the Middle East between Israel and Palestine. Whilst the region has long been regarded as something of a powder keg, the events that triggered this latest conflict seem to catch the wider world by surprise.
From afar, we sit aghast watching the unfolding news. Away from the human cost, when a geopolitical event such as this arises, its impact is inevitably felt further afield - especially in the financial markets.
There was an immediate impact on the UK forex exchanges. This, in turn, affects businesses on the Isle of Man that are engaged in international currency transactions. A spike in oil prices ensued and the GBP/USD rate lost ground.
Even before the situation started unravelling in the Middle East, the global economy wasn’t looking in rude health and markets were jittery. More market uncertainty now seems inevitable, which will keep the financial markets on edge.
The world is hoping that the war doesn’t escalate into a wider regional conflict but, even if it stays relatively contained, rising oil prices already seem to be part of the fall-out. This could lead to more inflation throughout the western world. It is precisely these types of economic adjustments that have a destabilising effect on currencies.
Dramatic cost differences in currency transactions
Earlier this month, in conjunction with the Institute of Directors, MFX staged a seminar about how businesses can best manage their exposure to currency – and how this can have a dramatic impact on business profitability.
As an example, we focussed on market volatility in one particular year –
2022, the year of the Russian invasion of Ukraine. Looking back, it’s possible to see the staggering cost of that volatility, without any trading strategy being in place.
Comparing the GBP/EUR, if you were buying €1 million, the cost in sterling could have been anywhere between £820,344 and £931,012. That’s a difference of 13.5% or £110,667.
Comparing GBP/USD, buying $1 million with sterling over the same period would have resulted an even greater variance - anywhere between £727,378 and £972,384. That’s almost £250,000 or circa 33%. How many businesses do you know that could absorb that kind of cost?
From this, it’s easy to see that currency fluctuations can have a major impact on a company’s financial performance. It highlights why it is essential to manage currency risk - especially if you are involved in switching large sums of money between currencies and/or transacting on a regular basis, e.g., where you are importing or exporting goods, paying salaries in foreign currencies, receiving fee payments, buying or selling overseas, even engaged in the repatriation of profits.
Each of these scenarios could be pertinent to your specific business operation or where you are acting on behalf of a client, which is often the case for corporate service providers with international clientele.
What FX tools and strategies are available to manage currency risk in your business?
Spot and Forward Contracts
Typically, this would involve spot contracts or forward contracts, known as hedging. A spot contract is where the payment is settled on the spot (normally within a day or two after the trading date). A forward contract is where the terms are agreed ahead of a future delivery or payment date.
Layered Strategies
For greater flexibility, however, especially where multiple or regular payments are taking place over an extended or on-going period, your trading strategy could also be layered. This could involve a combination of spot and forward contracts, whereby the overall rate achieved would be the average over the entire period covered.
This approach can be effective in providing protection against any unforeseen highs and lows within the underlying currency rate.
Adopting a layered approach can achieve a targeted rate without running the risk of being over-hedged. An example of this, where regular transactions are taking place, would be to lock in 100% of Q1's exposure at your costed rate and then have decreasing cover over the prevailing periods.
By using a layered approach, it can protect part of your future exposure, giving you peace of mind and allow you to proactively manage the remainder of your requirements.
With all the current instability and uncertainty in the world – and who knows what might spring up next – it’s vitally important to having your wits about you if you are exposed to international currency markets. Leaving everything to chance could turn out to be very costly.
About MFX
MFX are the Isle of Man’s only dedicated FX brokerage, partnered with one of the world’s leading FX specialist providers.
Since 2014, we’ve been helping local businesses reduce the risk, complexity and cost of international financial services by providing a secure, seamless and supported payments experience. Last year, we helped over 70 businesses with their banking, foreign currency and payment needs.
Transactions involve no hidden costs and low transfer fees.
To arrange an appointment, either call MFX directly on 01624 694722 or email david.shimmin@mfx.im
MFX Ltd is a wholly owned subsidiary of the AIM-listed Manx Financial Group and a sister company of Conister Bank.
