Volatile FX risky business

BANKS and risk management groups say the Australian dollar’s volatility makes it a good time for businesses to start using hedging instruments to protect against foreign exchange risk.

Hedging is a form of risk-management activity that allows companies to reduce their exposure to exchange rate changes that can arise from transactions in foreign currencies.

Fluctuations in the exchange rate can often be a source of risk for businesses that engage in international trade, which can, in turn, affect revenue streams and profit margins.

However, businesses can utilise ‘hedging instruments’ such as the forward market and options to help manage this risk.

Westpac head of financial markets Peter Bokeyar said the forward market was still the hedging instrument of choice used by businesses.

“The most popular hedging instrument is your basic forward exchange contract or the forward market, and in that instance the customer enters into an arrangement with the bank to exchange a certain amount of currency at a certain time and at a certain rate,” Mr Bokeyar said.

“Pretty much any kind of business can use the forward market, it is suitable for SMEs to major corporations.”

Five years ago, the Reserve Bank of Australia reported that the forward market was the most largely used hedging instrument, at 90 per cent, with options and futures forming the minority.

However, Oakvale Capital divisional director of foreign exchange and commodities, Vic Jansen, said the volatility of the dollar had led to a growth in businesses using ‘call’ and ‘put’ options.

“Options are like an insurance policy that protects against risk; they do involve paying a premium for that protection, but the option provides the most flexibility of any hedging instrument,” Mr Jansen told WA Business News.

An option gives the company the right to buy (call) or sell (put) an amount of currency for another at a future date at a pre-arranged exchange rate.

Mr Jansen said exporters had become reluctant to enter into forward contracts with the Australian dollar sitting at 30-year highs at US$1.07.

“It’s fair to say that as the dollar has gone up through parity the tendency for exporters to hedge has diminished a little,” he said.

“The market can change direction quickly and to be able to take up opportunity if the dollar was to fall suddenly has meant exporters are reluctant to commit to hedging positions above parity.”

However, NAB head of markets for WA Matthew Braysher said an increasing number of exporters were using options as a hedging mechanism.

“The Australian currency is so volatile, so a premium outlay of 2 or 3 per cent in a currency that’s moving at 20 per cent is not a bad risk reward,” he said.

“For exporters in particular, while it’s a bitter pill to swallow in taking out options at these levels, if they were to lock into a forward contract and then the currency falls, they are stuck in at very bad rates.”

On the other hand, importers are having a field day and are locking in forward contracts at the current exchange rate.

“Forward contracts have become more popular with importers again and we are saying to our clients that 30-year highs are a very good time to take risk off the table,” Mr Bokeyar said.

Mr Braysher said businesses that did not use some form of hedging were putting themselves at risk.

“I’ve yet to see many businesses that have such solid cash flows that they can afford to take this sort of currency risk, the Aussie dollar moved 20 per cent this year and you’ve got have a credible business to turn your back on hedging that sort of difference,” he said.