Companies scrap currency hedges as they seek to preserve cash

As their revenues collapse under the weight of coronavirus, companies are scraping together what funds they can, including by cashing in currency hedges.

Before the virus hit, many companies had taken out protection against big swings in exchange rates by entering into contracts with banks. For UK exporters, that meant shielding themselves against losses from a rally in sterling; for importers, the opposite.

But now that revenues for some companies have come to a sudden stop, they are unwinding those hedging agreements, like cash-strapped shoppers hunting for coins down the back of the sofa.

“There was a general desire to build up liquidity on the balance sheet as much as possible, so many chose to terminate or restructure their FX hedging portfolios, taking out as much cash as possible,” said Amol Dhargalkar, managing director at financial consultancy Chatham Financial.

One company that has taken this step is JN Wines, which supplies 2,000 restaurants and hotels in the UK and Ireland. “The bars and hotels are all closed. We are selling wine online — we won’t get new stock in until we have more certainty,” said James Nicholson, the company’s founder, from his base in Crossgar, Northern Ireland. Mr Nicholson has put on hold about 10 shipments of wine from the US, Australia and New Zealand.

That prompted him to terminate all his hedging contracts in recent weeks. Settling contracts early incurs a fee, but it is cheaper than following through on agreements to buy foreign currency that Mr Nicholson will no longer need.

Hedging contracts are agreed privately, so no data is available on how many companies are taking steps like these. But contracts have been liquidated in what one banker described as a “bit of a fire sale,” while few companies want to enter into new hedges until they have more certainty around their businesses.

Luca Annesanti, head of Emea FX corporate solutions at Nomura, said companies are typically most active in the first few months of the year, hedging a large proportion of their currency needs for the foreseeable future. “This isn’t happening right now,” he said. 

Historic swings in the pound’s exchange rate have turned many UK companies into big winners or losers from their currency hedges, but both sides have cashed in for different reasons. The sharp drop in sterling last month — when it traded below $1.15 against the dollar for the first time since the 1980s — proved to be an additional burden for UK exporters, who were facing not only cancelled orders but hefty losses on contracts designed to protect future revenues in foreign currencies. Sterling has since regained some ground to about $1.23.

Fabio Madar, co-head of currencies at NatWest Markets, said: “If the hedge [created a gain], they can rescue cash by closing out the hedge and settling it, but if the hedging outcome is negative it could create a direct hit on their financials.”

Mr Madar said his bank is helping clients sitting on losses “on a case-by-case basis.” Instead of having to settle a contract with a large negative balance, the bank sometimes agrees a new expiration date further out in the future, as well as locking in a new rate.

To ensure both parties to the contract can make good on their commitments, banks ask companies to park some assets with them as margin. The size of that margin varies day by day as prices fluctuate, creating a potential drain on companies’ cash.

Chris Towner, a director at Chatham Financial, said the extreme price moves of late have made margin calls a headache for even the largest companies, some of which had contracts in currencies such as the Norwegian krone, which dropped 30 per cent against the dollar in a couple of weeks. If banks respond by raising their required margin by 20 per cent, that could be “potentially big enough for a liquidity crisis” at some companies, he said. 

Iain Pelling is the managing director of London-based Arrow Media, a TV and film production company that gets paid for projects mostly in US dollars from its broadcasters. Under the terms of a forward contract taken out before the virus struck, he was faced with having to buy dollars at an uncomfortably high rate.

“When sterling sank to $1.15 we had a few forwards expiring, but luckily we had some dollars arriving early and we were able to settle the contracts with that,” Mr Pelling said.

For now, he added, the company is operating without hedges “until we know what happens next”.