By Willem van Lynden, Director of Sales and Marketing, Boost Capital
It’s been a great summer for a break in Europe, with Britons enjoying some of their cheapest trips to the Continent for years. Trouble in the Eurozone, with the threat of Greece leaving the European Union (EU), has seen the euro tumble in value against sterling. By the end of July, the pound was worth about 1.43 euros – the highest rate since 2007.
But while holidaymakers have been celebrating, it’s a different story for British businesses that rely on European exports. The EU is still the biggest export market for UK SMEs.
Their goods suddenly look expensive to those buying in euros, profit margins are plummeting, small rate changes cost UK firms thousands of pounds and many are losing business. What can exporters do to limit their exposure to currency fluctuations?
Why Europe matters
Europe is the destination for 43 per cent of all British exports, according to Government data. This is down from 51 per cent early last year.
Export prices fell in the three months to July by almost 20 per cent, analysis from the Confederation of British Industry (CBI). This is the fastest drop since October 2003, and the strength of the pound to the euro is blamed by many.
Which currency to use?
There’s no firm formula for which currency to use as an exporting business. Convention dictates manufactured goods are often invoiced in the exporter’s currency. Other areas of international trade are handled in a ‘vehicle’ currency, neither that of the importer or exporter. Some industry sectors favour certain currencies – aerospace contracts tend to be agreed in dollars, for example.
Invoicing in euros if your business trades mostly with Europe is a choice many make, largely because importers typically prefer working in their own currency. But this doesn’t alter the cost of production, which you might still pay in sterling, or protect against shifts in the euro’s value. Choosing which monetary denomination is right for your business is a difficult balance to find. For most SMEs, they simply opt to invoice in the same currency as their competitors.
Forward foreign exchange contracts
If the exchange rate moves against you between agreeing a contract and price for your export goods, you might end up worse off. To try to avoid this, many firms opt to fix an exchange rate for the payment or receipt of currency on a future date – a forward foreign exchange contract. Typically, banks arrange these transactions, which allow exporters to lock in the price of their foreign currency sales.
The merit of this type of arrangement is firms are protected against further negative moves in the euro, but the flipside is they’re tied in to the agreed rate even if the currency suddenly improves. However, it allows British exporters to plan and budget, knowing exactly what the cost of transactions will be in the medium term.
Currency options are similar to forward contracts, though more flexible – and more expensive. Under these arrangements, SMEs have the right to buy currency at a pre-agreed rate on a particular date, but, unlike a forward contract, they’re not obliged to do so. This means they can change their mind if the exchange rate worsens significantly or, indeed, benefit if things improve. But, as said, such flexibility comes at a higher cost in terms of charges.
Creating a natural hedge
Another method some firms use to balance their exposure to exchange rate changes is by importing as well as exporting to a given country or economic region. This means they hedge their position naturally, with lower foreign costs offsetting money lost elsewhere.
An example would be a UK clothing manufacturer importing cheap fabric from France, while exporting the final sewn product back to the European market. The cost of this company’s raw materials would be cheaper at present, due to the weak euro, which balances out the hit the firm is taking on its export costs. Clearly, this scenario doesn’t work practically for every enterprise, but where it’s possible, it can provide a useful level of protection.
Opening a foreign currency account in the UK
If you’re transacting in euros frequently, it may make sense to open a euro denomination bank account in the UK. Most banks provide this option, and euro accounts can be particularly useful if a business trades with more than one Eurozone country, as it hedges the firm’s risk across multiple borders.
The UK exporter can keep money in this account in euros – if their cashflow is strong enough and they won’t need ready access to these funds for day-to-day expenses – and use it when the exchange rate is beneficial to the business. This avoids the cost of exchanging currency, gives easy access to capital, and may even earn the company some interest on deposits. On the down side, it brings another set of bank charges, and exchange rates can take a long time to change, so it can prove a long game.
Opening a euro denomination account in an EU country
If you make and receive a lot of payments in the country to which you export, you may consider opening a bank account in that place. Again, if you’re unlikely to need the funds in the UK for a while, you then wait until the currency situation improves. Customers in the given country may also be more comfortable dealing with a bank in their own territory.
However, countries in Europe vary hugely in terms of rules and regulations governing who can open a bank account, and what’s involved in terms of bureaucracy, so it may depend where you’re exporting. Also, check to see what levels of protection and redress bank customers are given in a country before you commit your funds there. Plus, if you haven’t got the appropriate language skills within your team to communicate with foreign bank employees when important business matters arise, this may not be the most sensible approach.
With things still uncertain in many parts of the Eurozone, UK exporters to the EU are likely to have a continued bumpy ride in currency terms in the months ahead. Hedging your position isn’t a failsafe against the upset such changes cause – but it could lessen the damage considerably.