This article follows the previous one which presented the macro-economic situation related to the COVID-19 pandemic.

It offers company managers and decision-makers a reflection on the strategic planning exercise imposed by the impact of the pandemic in order to ensure a clear link between profitability objectives and the risks inherent to their achievement.

COVID-19 and Foreign Exchange Risk: business implications

In the coming months, the issue of COVID-19 and its impact on currency volatility will be one of the major challenges for companies. Geopolitical risks as reflected by the major macroeconomic issues and market volatility will be put into practice for all companies that are or will be reviewing their strategic planning.

Major Currencies – Background

The Japanese currency and, to some extent, the Hong Kong dollar, for example, have been relatively strong, despite their economic exposure to China. These two currencies are considered safe havens in Asia when markets break down; the Australian dollar is not so lucky. Also, the currencies of net commodity exporting countries, including Canada, have depreciated sharply in value. The Chinese yuan‘s (note 1) losses were limited by its growing status as a reserve currency, but more importantly, by the massive intervention of the country’s monetary authorities. The yuan weakened against the US dollar but appreciated against all other currencies. The euro had a rollercoaster first quarter and so did the British pound .

The U.S. dollar, with its status as the ultimate reserve and the gigantic intervention of the authorities at both monetary and fiscal levels, is holding up well. This kind of volatility in the major currencies does not bode well for the peripheral currencies. Countries are all facing a severe recession and a sharp acceleration in their financing needs.

The currencies of countries whose debt levels are already high (and/or) whose debt is in foreign currencies (and/or) which have a strong link to commodities (especially energy) should be sources of great volatility for the months, if not years, to come.

Companies in repositioning

Macroeconomic risks from geopolitical events are difficult to quantify (as are events like COVID-19) but cannot be ignored in your planning exercise. They impact the way we do business and their effects on currencies are fast, strong, and difficult to perceive over time (Risk Velocity).

These risks will be strongly present in the coming months, even years. They should sustain currency volatility, and even generate too much uncertainty on both the exporting and importing sides. This kind of ultra volatile market makes strategic planning and restarting activities difficult for companies.

Clear trends have disappeared or, at least, are increasingly uncertain, and the range of their possible variations is growing. Every forecast is faced with a more uncertain environment and pronounced short- and medium-term exchange rate rebounds.

Emerging stronger from the crisis

Although we must give all the necessary emphasis to the present difficulties, history teaches us that opportunities arise at the end of crises despite the deep breaks that have occurred. We must have the means to manage the volatility of the financial markets in order to make decisions with confidence for tomorrow.

Once you get through these difficult times, what strategic opportunities are available to you? It’s important to recognize that all the efforts you make now to get through it, strengthen you for tomorrow. Taking that moment to step back and assess those potential opportunities that can be seen emerging within any crisis is valuable.

A company with a strong balance sheet will be able to acquire or invest in companies that do not have this strength. An opportunity to diversify its product offering, reach new markets, integrate vertically, enter a new sector.

Development of scenarios as an early warning system

In the aftermath of this pandemic, companies are reviewing their game plan and examining the risks associated with their product (or service) offerings and supply chains as well as the exchange rates they will face.

Treasury management, the guardian of liquidity and market risks has never been as important as it is today. It protects cash flows, stabilizes liquidity and enables management to make informed and timely decisions through a careful analysis of the operating cycle and the appropriate use of hedging instruments (note 2). These are the attributes of a currency and interest rate risk management policy.

Components of your scenarios

First, there is the staff. Do the people who understand the cash position, liquidity, market hedging positions, etc. work in pairs with someone else? In short, who can quickly replace the treasurer or controller, just in case?

Your company’s risk tolerance must be reviewed considering recent events. With the resources that are expected to be available post pandemic, you need to re-evaluate your capacity to take risks. These tolerance levels must be reviewed.

For example, would you face financial difficulties if you were confronted with an adverse change in the exchange rate of 5%, 10%? Do you know this rate (alert threshold) and how it evolves? The risk map is modified accordingly.

Is this threshold consistent by product or lines of business i.e. what are your most exposed revenue (expense) lines? Do you need to restart these lines as a priority? Are they essential? Are your profit margins high enough to justify this risk?

When you review your product (service) offering and all its logistics, just as you add a risk premium to customers (suppliers) in an acute pandemic zone, or in a zone where health services are less well structured, you need a higher margin to justify a revenue (expense) line that is more exposed to foreign exchange (and/or commodity and/or interest) risk.

In short, up to what rate level (breakpoint) do you feel your buyers can continue to buy and, relative to your suppliers, up to what level can you continue to pay your suppliers and still be profitable?

Do you know your alert levels? What is Plan B? If you outsource manufacturing overseas, do you have a strategy in case you need to use a local manufacturer? If you sell internationally, can your buyer list be diversified?

To help you, map the criticality of inputs to distributed products (by margin size) and, therefore, to revenue streams.

Identify the components and commodities that have the greatest impact on revenue streams, and measure and understand their exposures to various risks (including currency) and, therefore, the impact on profitability.

Prioritization of activities in a context of capacity (production, distribution) subject to an external environment whose evolution seems to want to accelerate strongly.

Review these elements on a regular basis

In this context, reviewing cash flow, working capital management and inventory forecasts, as well as supply and demand forecasts based on these new risk weights is essential.

Moreover, the relevance of maintaining the hedging positions1 put in place before the pandemic must be analyzed.

It is likely that the hedging positions (note 2) taken by a Canadian importer, pre-pandemic, have a positive market value for the company and, if necessary, can become a source of liquidity. On the other hand, the hedging positions taken by the Canadian exporter have a negative market value, but they can be modulated to mitigate their impact on the company’s liquidity.

In short, risk management takes place within the operating cycle, where risks enter, change and leave the company (Summary Elements). Of course, foreign exchange is not the only risk, but it is a source of rapid disruption of significant magnitude (Risk Velocity), and even more so in the context of significant macro-economic issues. One of them could indeed become the next “black swan”.

Scripting to be prepared

In this context, it is crucial to understand and script how financial stability can be affected by these risks inherent to the business model. Determining the breakpoints and action levels for each of these risks and the actions to be taken in such a case is key to resilience.

Be as prepared as possible for the various scenarios. Scenario analysis must become the developing and alerting tool of plan B. We must be able to anticipate and not just react. Ensure that tactical and strategic business planning considers the potential of each of these risks.

The idea is not to take no risk but to know which ones are accepted, and up to what quantity; and which ones should be discarded from the start.

Special attention to dormant risks

By focusing on the assessment of the supply (distribution) chain and therefore the risk differential between global, regional and local flows, it becomes possible to ensure that the capacity constraint is allocated wisely in line with the company’s risk tolerance and that the risk/reward trade-off inherent in the business model is a sustainable solution.

This pandemic has brought to light some of the dormant risks of globalization. Therefore, steps should be taken by companies to uncover any other dormant exposures within their business model. It is the consideration of all risks that will strengthen the performance AND resilience of the enterprise.

Choosing a strategy also means determining the risks you are willing to take.

Globalization in rebalancing

Globalization has generated large integrated global networks, justified by economies of scale through outsourcing of manufacturing to emerging economies. The economy in general has accepted a little more (dormant) risk in the form of a weaker supply chain, in exchange for productivity gains.

However, events such as this pandemic, geopolitical risks, recent trade tensions, the possible integration of externalities such as the price of carbon, are forcing organizations to ask themselves if this is the right business model.

It is certainly impossible for most companies to completely move away from this model because of the size and quality of the supplier ecosystems in place; it is rather a matter of rebalancing.

Operating models that focus on manufacturing closer to the point of purchase will be promoted by companies to diversify their risks and secure their business models. These closer-to-the-point-of-purchase supply models should be less vulnerable to pandemics and geopolitical risks.

Risk management policy as an anchor for performance

Both supply chain and macroeconomic risks such as sovereign debt, tax changes, tariffs, trade quotas and resulting trade tensions, etc. will become increasingly important in the business environment. The impacts of any of these risks on the company’s operations are rarely isolated or short-lived.

Among other things, these risks have a direct and instantaneous impact on the frequency and magnitude of changes in currency values. Trying to predict the movements of the currency market becomes an unviable exercise.

Forecasts on the evolution of exchange rates over the next month, quarter or year become a less relevant tool for your strategic business planning. Your risk management policy becomes your anchor. This policy must systematically bring you back to your profit margin (Risk Management Policy).

A risk management policy built with Treasurisks allows you to be prepared to control the potentially adverse effects of an unfavorable currency movement while allowing you to capitalize commercially on favorable currency movements.

Adopt and maintain a clear risk mitigation strategy structured around your business scenarios. Plan how to respond to a range of risks. The faster you recover from an adverse event, the better.

The question that remains

The Chinese economy is the second largest in the world and is really the driving force behind manufacturing and industrial trends. It is positioning itself for a rebound. However, what can it do without consumers in the US, Europe and other parts of the world. The Eurozone has been hit hard by the COVID-19 pandemic, as has the United States lately. The European Central Bank will do what it can, but based on 2019 economic results, debt positions, and repeated signs of pre-pandemic recession, the economic outlook is quite weak. Emerging economies have experienced large outflows of funds as investors have redirected money to safe havens. When we look at the effect of COVID-19 on the health systems of developed countries, it becomes clear that the health systems in emerging countries, where some systems are still in early stages, are not prepared. The impact of COVID-19 on emerging economies will be long and severe. The question then becomes how long will this last? Much of the answer depends on the strength of the health systems (wherever they are in the world). Once the restrictions are removed, how long before growth returns? That’s hard to answer.

Note 1: The yuan is tied to the U.S. dollar in a range
Note 2: Option , futures contract, swap, etc.

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International markets: a world of opportunities

Expanding business abroad is a source of growth, but it also entails risks for SMEs. It is also complex to monitor the successive impacts of exchange rates on the company’s anticipated performance.

D-Risk FX Budget & BI, offers SMEs performance, risk and test scenario analyses, broken down by market, currency and business line, with a tailor-made hedging strategy and real-time monitoring of the company’s anticipated performance.

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