Brexit Lessons Learned: How to Prepare for FX Market Shocks

After 51.9% of UK citizens voted for a Brexit 0n 23rd June 2016, the pound plunged to a 30-year low and markets from New York to Tokyo were hit by extreme volatility. Although Britain’s finance minister assured that the UK was prepared for the unexpected, the pound lost again the following Monday. Post this date there has been further foreign exchange volatility with the GBP/USD dropping to 1.28 and then rising back to 1.32 and GBP/EUR falling to 1.16 and talks of parity abounding. Gold price has shot up to $1,341 per oz as a safe haven asset and crude oil volatility is still continuing.

In today´s global economy, Black Swan events like the Brexit impact corporations around the world. Estimates say Brexit has wiped out over two trillion dollars of value, worldwide. But not all companies are impacted the same. Differences will occur dependent on industry, geographical locations and exposures. Commonly, finance and treasury teams with contingency plans that have used scenario analysis and advanced risk management techniques to prepare for market shocks and to select desired end states are in a much better situation and more able to answer difficult questions from stakeholders.

However, in many finance functions FX risk mitigation and risk management is still at early stages. Here some examples of basic exposure management approaches and the typical excuses used to justify the lack of visibility and management:

  • FX risks are ignored, because they are difficult to control and treasury is not sure exactly where they arise and if there is any opportunity for FX netting.
  • Currency risks are managed by each business unit, because it´s difficult to coordinate across geographies.
  • FX exposures are managed without a defined risk framework, because local managers know their markets best.
  • FX risks are managed in spreadsheets, because proper technology is expensive.
  • Currency exposures are managed in isolation, because the effort of calculating risk correlations does not justify the savings.

Today, it´s a minority of risk managers that perform advanced risk analysis to accurately manage their foreign currency exposures. But several companies in the UK and Europe prepared for Brexit. One such company entered into binary FX options to hedge specifically against Brexit, another company performed advanced Cash Flow at Risk analysis for both possibilities, UK staying or leaving the European Union and a third company put in contingencies regarding some upcoming capital expenditure.

Let´s review what best practices sophisticated risk managers are currently performing:

  • Best practice 1: Global visibility and identification of all foreign exposures using an integrated forecasting tool
  • Best practice 2: First level and second level netting across all foreign exposures to identify natural offsets and reduce the number of external street trades
  • Best practice 3: Cash flow at Risk analytics across all asset classes to understand correlations amongst exposures and adapt hedging programs according. Using this model, corporates that are exposed to multiple risks are commonly able to reduce their risk by 40%-60%z.
  • Best practice 5: What if analytics across a range of hedging instruments to ascertain what risk the company is prepared to take and what are the most suitable instruments in the current economic climate
  • Best practice 5: Building out scenarios based on upcoming political events to understanding the business reaction to different potential outcomes and to decide whether to take action or not.

The Brexit reminds us how important it is to thoroughly manage FX volatility. Clearly, advanced exposure management cannot be done with spreadsheets or disparate financial tools. Global finance teams need treasury technology that provides visibility into cash positions and exposures on an enterprise level. They need cloud software that comes along with advanced scenario analysis and is easy to update in extreme market situations, helping them to prepare for Black Swan events and to adapt their hedging programs quickly to market volatility.

Read our press release for commentary on the Brexit. Review the White Paper “How to Align Growth, FX Risk Management and Technology” to dig deeper into FX risk management best practices.