Retail Industry Insights: Managing foreign exchange risk
In a volatile international currency environment, experienced operators are taking a risk management approach to foreign exchange and implementing strategies that minimise adverse currency exposure.
This situation is particularly relevant for retail businesses where pricing certainty and profit margins are at the forefront of decision making, financial modelling and overall performance. As the retail industry continues to globalise through online channels, movements in international currencies present an ever increasing competitive threat.
For many retail industry segments, notably in the discretionary space, there has been increasing margin pressure as competition and prolific discounting has become more prominent. As a result, businesses have less flexibility to pass the cost of currency movements to the customer and must consider the appropriate strategy to minimise this risk.
Why do I need a hedge strategy?
For retailers, like many other internationally focussed businesses, large currency movements can impact the financial sustainability of the company.
A hedging strategy can be implemented to limit the risk that exists within a business, but the right strategy for each business may differ depending on exposure levels.
This can be considered in three ways:
1. Systematic hedging – applies to committed FX exposures
2. Active hedging – discretionary hedging of committed and uncommitted FX exposures
3. Dynamic hedging – discretionary hedging of uncommitted FX exposures
Selecting a hedging strategy
With a broad range of strategies available to businesses, decision makers must be considering how best to hedge their exposure.
When selecting a solution, there are a number of key factors to consider:
- Certainty of hedged cash flows
- Tolerance of opportunity cost
- Hedging budget
- View of where rates will go
- Trade-off between risk and reward
A hedging policy forms the backbone of risk management strategy, and businesses can adopt a structured view of identifying and addressing currency risk. The final selection requires an acute awareness of the risk and rewards on offer, and techniques such as backtesting and forward-looking analysis are vital tools to determine this.
To find out what risk management tools are available for businesses, or further information on currency markets, read Global Markets.