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Minimising Financial Risk in an Uncertain World

Gordon RateGordon Rate leads the Bank of Scotland’s Financial Markets business in Scotland and the North of England. His team works with businesses to identify and manage financial risks, including interest rate, foreign exchange and commodity risks.

Rarely has there been a time when economic predictions have been harder to make. The fall in the value of the pound after the EU referendum – and exacerbated by the recent base rate cut – may have ramifications for Scottish companies. It’s a wake-up call for manufacturers. So, what should you be doing now?

The answer to that is that you should be thinking hard about how best to manage financial risk in this uncertain world. How the fall in sterling affects a business depends on your international trade, whether you have subsidiaries abroad and whether you import or export. The dollar and the euro now cost more, and these are the two important currencies for most Scottish companies. The dollar rate doesn’t just affect trade with the US, of course, but with China and other parts of Asia where this is the currency of choice. British Airways, for example, was one of the first UK companies to post a profits warning[i].

So what do we know? Well, we know that the potential for continued economic and political uncertainty could knock both consumer and business confidence. We know that UK financial markets could continue to be volatile until the dust settles. And we also know that a cheaper pound could make the UK look more attractive to foreign investors, but is only one of the factors that they consider when making those decisions.

There are winners and losers. Importers of components and raw materials are seeing their costs increase, while exporters now have a cost advantage in that their products are cheaper. Fashion brand Burberry, for example, exports more than it sells domestically[ii] and the Scottish whisky industry exports were worth £3.88bn in 2015, although 40% of that was into the EU single market[iii]. Multinationals may have an advantage in that the value of their foreign earnings can help the income statement of the UK-domiciled company. Longer term, there is the potential for UK trade deals with other parts of the world to be made more nimbly out of the EU.

Two facts highlight how significant this is for Scottish manufacturers. Firstly, manufacturing represents more than half of Scotland’s international exports and investment in research and development, with nearly 190,000 people employed in the industry[iv]. Secondly, the Ernst & Young 2016 UK Attractiveness Survey reported that, in 2015, foreign investment to Scotland was at its highest level on record, creating more than 5,300 jobs[v].

The political environment does, however, remain uncertain and the negotiations around the UK’s exit from the EU have yet to develop. In September, the petition for a second referendum will be discussed in the House of Commons and the EU will hold a summit (without the UK) to discuss the way forward. In October, it’s the Conservative Party Conference. In November, the US presidential election and the UK’s autumn statement. Next year, there are elections in both France and Germany[vi].

The question for Scottish manufacturers is whether they can afford any further movement in the pound, and how best to avoid any fall in profitability. There seems to be potential for major movement in either direction.

In practical terms, company treasury teams should be re-examining their financial risk and seeking insights into currency hedging options. For many, agreeing an exchange rate now and locking that in provides security for the short- to medium-term. The downside, of course, is that companies lose the exchange benefit should the currency move in their favour. Having a risk management strategy gives manufacturers a way to weigh up those pros and cons and secure their futures, whatever happens next.

[i] http://www.theguardian.com/politics/2016/jun/24/brexit-vote-business-leaders-call-for-urgent-action-to-shore-up-uk-economy
[ii] Adam Chester, Head of Economics, Commercial Banking, Lloyds Bank – 16-07 Financial Director – impact of sterling on businesses with interna.doc
[iii] http://www.scotch-whisky.org.uk/news-publications/news/optimistic-outlook-for-scotch-whisky-exports/#.V5XvBFcaqXg
[iv] http://www.businessforscotland.co.uk/70-million-investment-in-scottish-manufacturing-industry/
[v] http://www.gov.scot/Resource/0050/00502490.pdf
[vi] 20160714 BOS – Political Events That May Drive Spot Movement In GBPUSD G…