Minimizing the risk of foreign currency transactions

Experience Banking

Not Everything Can Be in Euros

Companies that conclude transactions in pounds, renminbi, or other foreign currencies take on a currency risk. Thanks to LBBW, this risk can be hedged.

The German economy is booming, with German-made quality in demand all around the world. The export ratios of German companies are reaching new highs every year. In 2017, goods worth EUR 1,279.4bn were exported, 6.3 percent more than in the previous year. The total value of imported good also increased, coming to EUR 1,034.6bn. But the figures calculated by the German Federal Statistical Office in euros were not necessarily paid in euros.

German companies settle almost half of their international transactions in dollars, yen, renminbi, pounds or other more exotic currencies. In doing so, they expose themselves to the risk of fluctuating exchange rates. According to Frank Schmidt, Director of Interest/Currencies/Commodities Solutions at LBBW, this risk is often underestimated, especially by SMEs.

LBBW Research

Risk due to fluctuating prices

Forecasts of future exchange rate movements are often "too casual." "The exchange rate applied by companies in their projections often fails to reflect reality. Significant deviations can lead to losses," says Schmidt. "But this is not an inevitability. Currency risk can be managed."

End-to-end analysis instead of "casual" forecasts

LBBW's experts develop tailored strategies for corporate clients, starting with an end-to-end financial analysis. "We intensively address a company's key performance indicators (KPIs)," explains Schmidt. "To ensure that the entire process does not become overloaded and the cost for the client remains reasonable, we limit ourselves to the KPIs that are central to currency risk." LBBW then comes up with a recommendation for the optimal hedging ratio based on transparent steps and can also compile a suitable set of tools and instruments in conjunction with LBBW's derivative specialists on request.

The end-to-end financial analysis focuses on the following key questions:

  • What is the maximum possible loss from foreign exchange transactions?
  • What risk of loss is the company willing/able to bear?
  • To what extent is it necessary to hedge this risk in order to prevent a significant downturn in the company's KPIs?
  • To what extent will hedging reduce the risk of loss, e.g. with regard to the return on equity?

To find the right answers, LBBW's experts run simulations for each risk position based on past exchange rates and forecasts of future exchange rate development. They also calculate how likely these deviations are and how much of a risk they could pose with regard to the customer's KPIs. All of this results in a recommended hedging ratio.

Tailored strategy to counter currency risks

"Our experience shows that a tailored hedging strategy can significantly reduce currency risk," says LBBW expert Frank Schmidt. But insisting on paying in euros is not an alternative, as the use of a different currency is not always entirely voluntary. Certain transactions are always concluded in US dollars, such as gold, oil, and other commodities. In some countries, foreign exchange regulations prevent transactions from being settled in euros, while for some partners switching to a different currency simply makes it easier to conclude the contract – and to settle it later.

Even relatively small exchange rate swings can result in the company generating a few thousand euros less than planned. But thanks to LBBW's hedging strategies, this can be avoided.

In fact, choosing to do without the euro can represent a competitive advantage. Companies that settle invoices with Chinese partners in renminbi, for example, demonstrate trust – which is generally conducive to further cooperation.

There is no trust without risk, as payments are generally only made on delivery. For example, if a company sells a machine to the UK for GBP 100,000 now, it does not know how much it will get for it in euros in six months' time. Over the past three years, the British pound has fallen by almost 20 percent. Although the exchange rate is currently fairly stable, there is no guarantee that it will stay that way. And any drop in the British pound will have a direct impact on the GDP 100,000 machine. Even relatively small exchange rate swings can result in the company generating a few thousand euros less than planned. But thanks to LBBW's hedging strategies, this can be avoided.

Are you interested in currency hedging for your company or an end-to-end analysis? Get in touch with us:

Frank Schmidt

Interest/currencies/commodities expert
for "Sales Corporates" solutions
Tel. +49 711 127-28184