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Brexit effect: Use of FX options by large UK corporates is up

As the UK's parliamentary Brexit stalemate continues, businesses are left still not knowing how they should prepare for the UK's departure from the European Union. Supply chains will have to adapt to different customs procedures and tariff payments, while any of the possible outcomes is likely to have a significant effect on sterling FX exposures. With just over 60 days to go before the automatic exit on 29 March, the chief executive of Airbus, a European firm that employs 14,000 people in the UK, said it's a "disgrace" that businesses are still not able to plan for Brexit.

This article by HSBC's James Edwards, FX Structuring, EMEA, notes that many corporate treasurers have already found themselves caught out once by Brexit. When the referendum surprised the financial markets with its 'leave' vote in June 2016, Edwards writes that: “companies were left with significantly different hedging rates for underlying exposures from late 2016 into 2017. Some of those with GBP costs/USD revenues to hedge found themselves with large mark-to-market losses that had filled their credit lines with banks, stopping them from taking advantage of lower spot levels, or, worse still, receiving demands for margin payments where credit terms were more restricted.”

Is it likely that corporates could be wrong-footed again? As the way forward between now and the end of March still seems very unclear, unexpected currency movements are perfectly possible. According to HSBC's research, sterling could go 14 per cent either way against the dollar, with a low of $1.10 if the UK leaves with no deal at all, or a high of $1.45 if the UK actually decides to remain. Edwards then goes into more detail about option-based hedging of FX risk, which he says could “add a degree of flexibility, particularly in the event of another significant sudden move.” He adds: “However, the rise in option purchases has not been as acute yet as we saw in 2016, though their use by large corporations is up.”

Finally, Edwards warns that businesses are facing a period that will be particularly prone to currency volatility, and that choosing a hedging instrument to cover all eventualities, matching cost and flexibility with benefit, will take a lot of consideration. He writes: “A key point to highlight to risk managers is how quickly moves can occur. A fall of almost 18 cents took place in 6 hours in June 2016 – and well before almost all corporate treasurers in Europe were at their desks. Irrespective of whether you have a view on whether Britain’s relationship with the EU will be settled by 29 March or not, there’s plenty of scope for significant volatility up to that date. It might be the result of one of the UK’s House of Commons votes, a statement from the European Commission or a statement made by a political leader at any time that creates a dramatic shift in expectations. Guessing when that event might come and how the whole Brexit story pans out might be the riskiest of all choices available for FX market participants.”

This item appears in the following sections:
FX Management & Crypto
Buying & Selling FX
Risk Management
FX Hedging & Risk Management

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