Multinational Corporates Face Rising FX Hedging Pressure

The victory of Boris Johnson in the U.K.’s Conservative Party leadership contest is only the latest geopolitical event sparking concerns among analysts over foreign exchange (FX) markets — and corporates’ ability to react to those changes.

With Johnson named as new Prime Minister, analysts are again shifting their focus on the execution of Brexit and how FX markets will be impacted.

“With such an outcome having been largely expected, sterling’s immediate reaction has been muted as the news was already priced in,” reflected Caxton FX currency expert Michael Brown in an interview with Express.co.uk following news of Johnson’s victory. “However, focus will quickly switch to the next steps — namely, cabinet appointments and the Brexit plan. The latter will be of more importance for markets, with sterling set to remain under pressure should Boris continue his ‘do or die’ Halloween Brexit stance.”

“Cautious” seems to be the term analysts are using as more geopolitical pressures shake up the FX markets, and disrupt corporate treasurers’ ability to hedge against those risks. From Brexit to the U.S.-China trade war, to a new trade dispute brewing between Japan and South Korea, FX hedging is now more complex, yet more necessary, than ever for multinational corporates and small businesses.

An Eye On Emerging Markets

KPMG recently advised small businesses in the U.K. to prepare for Brexit by bolstering their cash flows, analyzing their current supply chains, and speaking with their banks about how to protect themselves post-EU exit, particularly amid growing concerns that U.K. banks will face a credit shortage following Brexit, leaving small businesses without access to capital.

And while expected currency fluctuations resulting from Brexit will surely mean U.K. businesses and their partners around the globe must hedge against FX risk, the latest analyst from Citi warns that FX hedging should be a top priority for companies in emerging markets.

The financial institution recently published its global corporate benchmarking survey, finding that 80 percent of corporate treasury respondents report having exposure to emerging market currencies.

Yet a similarly-large portion said they do not adjust their FX hedging strategies whether their exposure is to G10 currencies or emerging market currencies — a potentially expensive mistake considering current market volatility today.

Further, Citi found, corporates’ hedging policies are often reliant on manual processes as treasurers struggle to integrate their firms’ enterprise resource planning (ERP) and treasury management system (TMS) solutions with each other.

“As a consequence, they are relying on the hedging policies they already have in place and are constantly looking to revamp these policies, which extend a cross a full breadth of their FX risk,” explained Citi global head of risk management solutions for corporate FX Jaya Dutt, according to recent Euromoney reports. “This can lead to capital losses and have a negative impact on loans taken out by local subsidiaries if risk practices don’t take account of emerging market currency volatility and liquidity.”

Vietnam, Jamaica Urge FX Risk Mitigation

Citi’s recommendations coincided with an announcement from Vietnam earlier this month that it would be relaxing FX hedging restrictions that had come into place in the wake of the global financial crisis.

“We have been discussing with the central bank how to create a [FX] hedging instrument,” said Vietnam State Capital Investment Corp. Chairman Nguyen Duc Chi during a conference in London, according to Reuters reports in early July. “[The central bank] are looking at it at the moment. My view is that in a 2-3 year time frame you might start seeing more relaxation in terms of hedging.”

More recently, a Bank of Jamaica survey revealed a constriction in local banks’ foreign exchange forwards or hedging contract agreements. In response, former Jamaica Chamber of Commerce President Larry Watson noted that small- and medium-sized businesses need greater access to FX hedging solutions from their banks as they continue to face exposure to FX volatility risks.

“I am encouraging the financial institutions to become more active, not only in [offering FX forwards] but also marketing it and explaining to businesses so that they can be more aware of what is available to reduce their risks,” Watson later told the Jamaica Observer.