BPI NEWS BUSINESS ADVICE
“A firm wanting to see if the exchange rate is moving in their favour, and who wants to wait to see if there is some advantage to be taken from that trend, should consider a ‘stop loss order (SLO)’” find that forward contracts are the tool of choice for payment of invoices on 30, 60 or 90 day terms, as they provide exchange rate certainty for the whole credit period. Forward contracts are also used where goods are received on consignment, or where letters of credit are required. A firm wanting to see if the exchange rate is moving in their favour, and who wants to wait to see if there is some advantage to be taken from that trend, should consider a ‘stop loss order’ (SLO). “This device is placed into the foreign exchange market, with a market maker, to guarantee a minimum exchange rate. The order sits as a latent instruction, but isn’t actioned until the market moves in such a way as to trigger the order,” explains Johnson.
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He illustrates the point with an example: A distributor needs to buy US dollars and the current market exchange rate is $1.42. If the trend looks like it is heading higher, they may be tempted to wait for a better level, but the ever-present risk is that the trend changes and the pound slumps to $1.35, wiping out any profit. Let’s assume they cannot make a return on the contract unless they can achieve at least $1.40 or better. In these circumstances, they could place a ‘SLO’ at $1.40 to guarantee that rate as the worst-case scenario, while leaving the opportunity to buy at higher levels if the pound continues to rally. Essentially, even if the pound collapsed, as soon as the sterling – US dollar exchange rate fell to $1.40, the order would be triggered and they will have bought their US dollars. There is another alternative to the SLO: ‘options’, which are used by many companies, especially where they have sizable requirements and/or long term projects. Johnson cautions that they can be expensive because ‘plain vanilla options’, as the basic form is termed, require the payment of a non-refundable premium, yet they serve the same basic purpose as an SLO. The flexibility in an option is in the right not to exercise the right to buy at the option level, unless needed.
Using volatility Automated orders can be used in another way. A ‘limit order’ can be used to target an advantageous exchange rate, which is above the current level. According to Johnson this works because the foreign exchange market doesn’t rest. Trading begins on Sunday night UK time and continues around the clock until the US markets close on Friday night. “One by-product of this is that some of the most volatile periods occur when individual markets are opening or closing; this volatility can be captured by placing automated limit orders at pre-determined exchange rates. As long as the market trades to the nominated level, the order will be filled.” Clearly firms need to plan ahead. To a large extent, planning is the key to every aspect of success in managing your currency needs. If you ask all of your questions in advance, dot all the i’s and cross all the t’s, you will suffer fewer shocks and avoid nasty surprises.
What next for the trade after ‘Brexit’ vote? THE ELECTORATE SPOKE last month, and, whilst the dust was still settling as we went to press, the UK is poised to leave the European Union. The result is another blow for the polling profession – they got the predicted outcome wrong in the 2015 election and appear to have got it wrong again. Those in a shock at the outcome were given a chance to catch their breath in that Prime Minister David Cameron went back on his original promise to immediately trigger article 50 of the Lisbon Treaty, the clause determining how a member state leaves the EU – despite Brussels calling for the UK to do so, in order to avoid ‘contagion’ from our own referendum spreading abroad. It’s also worth noting that a referendum isn’t binding – it’s indicative only. However, in a democracy it’s a moot point and we will now surely leave the European Union. The questions to be answered now are what now for our wider economy and the retail trade in particular? The immediate wake of the vote saw Mr Cameron and Mark Carney, the Canadian Governor of the Bank of England, trying to steady the ship in the face of financial markets predictably in a panic. Consider that in the summer of 2015 the Pound against the Euro had risen to €1.42, but by the start of the week of the vote it was down to €1.24. As the polls closed it had risen to €1.31, but once the vote result was made public it had dropped through the floor to €1.22. The Dollar did something similar and fell to €1.32 – a 10% fall and a rate not seen since 1985. The London stock market was equally in turmoil and had fallen more
than 8% over the morning before recovering to only being 4% down – again, something not seen since the collapse of Lehman Brothers in 2008, the precursor to the last recession. Other global markets followed suit – Italy was down 11% while Germany was down 7.5% and France had lost 9%. The only saving grace is, as Mr Carney put it on the morning the outcome was known, that the banks have more cash in reserve and have been stress-tested so that bank failure is very unlikely.
Trading with Europe The other point to make is that UK law, at least that based on EU legislation, isn’t going to change overnight and in many cases will mirror whatever Brussels passes. Why? Because if the UK is to trade with Europe we’ll have to comply with their rules, even though we’re on the outside and unable to exert any influence. In other domestic matters, such as health and safety and employment law, it would take a very brave government indeed to repeal legislation that gives, for example, workers holiday entitlements and rest breaks, while protecting individuals from discrimination. What will be interesting to see is how, post exit, UK firms do in recruiting staff, as it’s entirely possible that the automatic right of EU nationals to live and work in the UK could be curtailed (and vice versa). Of course, there is also the possibility that businesses with a majority interest in Europe will simply up sticks from their UK bases and move to the continent.
Continues next page… BPI News | July/August 2016 29