RISK MANAGEMENT | 23 November 2023

Black Friday: Retail’s
Untold FX Story

Absa-CIB-Author

Shahied Lodewyk

Trader, FX Sales Absa

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Behind the Black Friday deals and festive season sales there’s an untold story of how retailers need to mitigate their foreign exchange risk.

During retail’s silly season, when Black Friday extends into Black November and the end-of-year sales, few consumers give much thought to the foreign exchange (forex, or FX) risks and the mitigation of those risks happening behind the scenes. However, for Shahied Lodewyk, FX Sales Trader at Absa, and the Absa FX team that’s top of mind. “FX is a key consideration for our retailer clients when planning for this time of year,” he says.

Pause for a moment, and it’s easy to see why. Retailers will import goods today and sell them later – and in between, there might be wild fluctuations in the currency exchange rate. Suddenly, they might find themselves having bought the stock at, say, R18 to the US dollar, but when it’s shipped or sold the rand may be at R20 to the dollar.

Retailers’ FX dilemma

“Each company is unique in how they approach FX risk management,” says Lodewyk. “Some retailers will cover line item by line item, taking out cover on this basis; while others may cover their FX exposure in bulk. Either way, the exposure is the same. There is a foreign exposure that needs to be managed before the goods are shipped.”

As a start, in order to mitigate FX risk, retailers need to have a clearly defined hedging policy in place. “The policy will dictate the products that may be used when hedging exposures and often stipulates the minimum and maximum exposure that may be in place at any given point in time. These parameters are approved by the Board of Directors and generally talk to the company’s risk appetite.”

The hedging theory may seem simple, but in practice it’s complicated given the rand’s volatility. In mid-2023, for example, the currency bounced from R19.78 to the dollar in May, dropped to R18.23 in June, spiked up to R19.10 in July and then subsequently fell to R17.27 later that month.

“Given the intense competition, retailers are continuously looking for ways to keep their cost of goods contained,” says Lodewyk. “Actively managing FX risk is a tried and tested way in which retailers can minimise the need to pass on additional costs to consumers.”

Managing FX risk

Absa offers a wide range of FX risk management tools. “In order to achieve the best results, we advocate a balanced portfolio approach,” says Lodewyk. “Given the potential fluctuations between when an order is placed and when payment is due, a blend of FX products generally performs better than a single product type.

“The first product is a Spot transaction. These should be used closer to payment date to top up cover where necessary. Beyond spot transactions which are settled two days after the transaction date, retailers enter into various hedging products. The first such product is a forward exchange contract (FEC). An FEC provides certainty regarding the exchange rate payable on an agreed future date. This the rate will be used to calculate the costings that will be passed on to the consumer.”

However, Lodewyk does not recommend using FECs as the only hedging tool. “Anything is possible in the volatile FX market,” he says. “We propose considering the law of averages. As an example, a client who needs to purchase $1 million within the next 12 months could potentially hedge 20% immediately. The exchange rate can then be monitored for favourable moves and additional cover executed at certain acceptable levels. This is referred to as actively managing FX risk.’”

A portfolio approach may also include options or derivatives that give the client the right (but not the obligation) to buy or sell FX on a specific date at a specific price. “FX options are attractive in that these products can offer protection and allow retailers to participate in favourable movements in the rand,” he says.

Safety in FX hedging

To further assist clients with FX risk management, Absa provides a free treasury management system which enables effective administration, policy compliance and hedging & strategy functionality.

“Managing FX risk is unpredictable,” says Lodewyk. “As much as one can attempt to predict where the currency may be heading, unexpected external factors – be it a pandemic or a war in Europe – could impact the currency. The crucial aspect to remember, though, is that FX risk management focuses on risk mitigation, and not on profit from currency movement.

“Retailers’ core focus lies in selling goods,” he concludes. “They are not – or should not – aim to profit on FX transactions. A corporate treasurer who effectively executes the company’s hedging policy can be reassured that everything possible has been accomplished to reduce FX risk.”

Absa-CIB-Author
Shahied Lodewyk

Trader, FX Sales Absa

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