Doing business internationally comes with a variety of benefits and challenges—not least the risk that currency values will shift in the time between inking a contract and payment.
One way to protect against losses as a result of currency fluctuations is hedging, working with a bank to lock in an exchange rate that will be honored at the time of payment.
The U.S. dollar has been on a roller-coaster ride since Donald Trump’s victory in November. It surged initially, then retreated in January before regaining ground this month. Against the euro, it was trading midweek some 4 percent higher.
As Rochester area companies increasingly look to international markets, it is a strategy some financial advisers are recommending.
“When people think about managing currency risk, they think of flashing red and green lights on a screen watching the euro,” said Jeff Morse, managing director of corporate finance for Brighton Securities Corp., who has worked with a number of clients on hedging strategies.
But currency hedging is more like insurance than an investment strategy when it comes to businesses that buy or sell abroad, he argued. It also can help U.S. businesses remain competitive when a strong dollar might discourage some from doing business in American dollars.
Michael Pavia, president and CEO of Sydor Technologies LLC, likens it to locking in a mortgage rate on a house before you close. Only in Sydor’s case, it’s more like locking in rates on five or six houses.
“We definitely needed it because, at times, it’s been over a million dollars,” he said of foreign sales.
In addition, Sydor owns a company based in the United Kingdom that does business in France. Sydor thus hedges currency for transactions that involve both the British pound and the euro. Pavia also has many colleagues who do business with Canada and protect their margins with currency hedging.
“It’s a good strategy to protect your business if you’re doing any international business and dealing with foreign currency,” Pavia said.
Sydor has taken advantage of currency hedging for the last 10 years or so, he said.
Mark Kovaleski, managing partner at Mengel, Metzger, Barr & Co. LLP, said hedging is something more businesses might want to consider.
“It’s probably underused,” he said. “I think the larger companies use this, but for the smaller, family-owned businesses, it’s probably underutilized.”
Morse said there are two main reasons to consider hedging. One is to remain competitive and make it easier for companies outside the U.S. to do business with you. Insisting on doing business in U.S. currency means the customer will have to account for the risk of currency volatility on his or her end.
“You shoveled the risk to your counterpart—so you are paying for it,” he said.
The second major reason is to protect margins or profits when doing international deals.
“It’s all about risk management,” Morse said.
Currency hedging typically involves working with a commercial bank and doing a forward contract or option contract that guarantees the exchange rate for a given date or timeframe.
And while there is some cost involved, banks are managing currency risks on a large scale involving many contracts so fees are typically reasonable.
“The spreads are very, very small when you work with a commercial bank,” Morse said. “It’s a very cost-effective way for companies to hedge out their currency risk.”
The circumstances that make currency hedging valuable can include orders for large ticket items that take time to manufacture. A six-month delay between the order and delivery exposes the parties in a transaction to more currency volatility.
It is also a useful strategy when there is a high volume of repeat business in a given region, or when a company is involved in a cross-border acquisition. In all these cases, a significant change in valuation can catch a business owner by surprise.
“There are plenty of macro political forces out there that are incredibly hard to predict,” Morse said. Hedging is only one of a number of risk management strategies to consider.
Companies do need to have specific accounting protocols in place, however, since recording these transactions can be complex, Morse and Kovaleski said.
“Basically, this is an insurance that will help limit your exposure to exchange rate volatility,” Kovaleski said. “It really comes down to a cost consideration.”
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