Given the ongoing uncertainty around Brexit and the resulting currency fluctuations, it would be reasonable to expect that corporate focus on hedging has heightened – or at least remained consistent – over the last year or so, with an attendant rise in demand for forwards to mitigate FX risk.
However, conversations with brokers reveal a more nuanced market where forwards volumes are up at some firms and down at others, with corporates appearing to be willing to take their chances on currency movements.
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Carl Jani, Argentex |
Carl Jani, co-CEO of Argentex, which manages foreign exchange transactions for clients across EMEA, says that despite trading 28% more currency last year than in 2017, the percentage of that volume represented by forward contracts at his firm fell from 42% to 32% in 2018.
That trend has continued into the early months of this year, during which time only 20% of the firm’s trades have been made through forward contracts.
This decline in the proportion of corporate clients hedging their currency risk forward is indicative of the tentative mentality of the market.
“Businesses are effectively waiting for currency movements to make their trading decisions for them,” says Jani.
There are several factors behind this behaviour, he explains.
“Firstly, corporate treasurers have already been caught out once by Brexit when the surprise result of the referendum hit the market in 2016. They are reluctant to let that happen again and ‘stick their neck out’ with a forward contract for fear of further embarrassment and financial losses.”
Many big banks are also overly optimistic on sterling forecasts, and this underappreciation of downside risks is discouraging corporates from hedging.
“We are not in a place where being bullish on sterling is a sensible move,” Jani adds. “Political risk is not just Brexit-related; it also exists in the form of election risk. If [Jeremy] Corbyn takes power, many argue it would be worse for the pound than a no deal, and we are inclined to agree.”
In addition, the average tenor of Argentex clients’ forward contracts has almost halved from 153 days in 2017 to 86 days in 2019 to date. The firm ascribes this decline to a belief among treasurers that there is insufficient visibility in the market.
Moving forward
Trevor Charsley, senior markets adviser at global payments company AFEX, nevertheless refers to a 20% year-on-year increase in forward hedging volumes in January, as some clients stockpiled goods at the start of the year and front-loaded their FX needs in anticipation of the UK exiting the EU in March.
“We have had clients who normally hedge for three months deciding to extend to six months, while those clients who usually hedge for six months were prolonging hedges to up to 12 months,” he explains.
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Trevor Charsley, AFEX |
FX forward volumes more than doubled last year at broker Sucden Financial, observes the firm’s chief dealer, Daniel Henson, with a further substantial increase expected in 2019.
“We have seen increased demand for longer-dated forwards with corporates that have previously hedged for one year now looking at two to three years and examples of corporates hedging up to six years forward,” he says.
AFEX’s experience of increasing use of options among its client base is in line with the findings of the Bank of England’s most recent Foreign Exchange Joint Standing Committee FX turnover survey, which reported a 15% increase in options turnover.
Charsley observes that option volumes rose at an even faster rate than forwards at his firm during the first three months of this year.
“Clients wanted to protect against a no-deal Brexit and purchase their currency against sterling at near current levels,” he explains.
“However, they also expected a deal to be agreed between the UK and EU, with a potential rise in sterling on this news. Hence, they wanted a product that could give them the ability to protect against a sterling fall and at least partially benefit from a rise in the value of the currency,” he continues.
Disagreements
When asked whether divergence in hedging strategies could be attributed to disagreements within treasury teams or finance departments, Jani suggests such discord is more likely to occur between treasury/finance teams – even the CFO – and the CEO.
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Daniel Henson, Sucden Financial |
“There has been a trend over the last few years for corporate treasurers and risk managers within the finance function to sit at the board table and provide advice to the management team,” he says.
“To influence strategy, finance teams need to acutely understand the current FX landscape and ensure they are properly communicating the risks to the management team.”
Jason Hughes, global head of sales at ADSS, a trading firm headquartered in Abu Dhabi, agrees that in an environment where there is uncertainty and huge potential for event risk, it is likely that there will be different views between departments and potentially even within the same team.
“Most arguments are likely to be related to the timing or amount of the position the company needs to cover and therefore the amount of risk it continues to hold,” he concludes.
“In most organisations the risk policy and agreed risk limits should cover most of these scenarios in terms of what is permitted, but that doesn’t mean disagreements won’t happen.”
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