How it has started and where we might be going Institute of - PowerPoint PPT Presentation

‘Brexit’ – How it has started and where we might be going Institute of Chartered Secretaries and Administrators – CPD Series 02 March 2017 Cormac Little and Eoin Caulfield, William Fry Brendan Donovan, AIB Bank williamfry.com

Foreign Exchange Risk and Solutions ICSA Ireland Region Presentation Thursday 2 nd March 2017 Brendan Donovan Head of Commercial & Business Treasury AIB Customer Treasury Services

Overview of Euro-Sterling movement since January 2016 20% Sterling Depreciation (91p) US Election (86p) Pre Referendum Result (76p)

Overview of Euro-Sterling movement over past decade 2008 (98p) 2016 (91p) 2015 (70p) 2007 (65p)

Overview of Euro-Dollar movement since January 2016 20% Sterling Depreciation (91p) US Election (86p) Pre Referendum Result (76p)

Overview of Euro-Dollar movement over past decade 20% Sterling Depreciation (91p) US Election (86p) Pre Referendum Result (76p)

Trade is the key consideration in Brexit UK Dependence on EU FDI / City of London Trade Deal Options UK puts sovereignty ahead of Very close links between UK & UK biggest recipient of FDI in access to single market – thus rest of EU, which takes 45% of EU. London centre of Europe Norway and Swiss type trade UK exports financial services industry deals ruled out by UK Free Trade Agreement Hard Brexit Likely Hard Brexit would see UK UK likely to seek its own FTA leaving the EU Customs with EU, but like Canada, it Union and Single Market, will take years to negotiate, while current EU trade deals may still not include services, with other countries would still have to abide by EU rules no longer include UK

Brexit is a major headache for Ireland • Sterling has fallen sharply on Brexit • Higher trading costs from more • Brexit has serious implications given concerns, which hits exports to UK administration, differing trade rules close economic/trade links with UK Trade with UK equates to 35% and regulations, compliance costs, of Irish GDP . Thus, it is a key • Also impacts Irish firms competing • Trade with UK equates to 35% of possible customs duties and tariffs trading partner with UK exports to Ireland and third Irish GDP . Thus, it is a key trading • Brexit could impact considerable country markets partner cross-country investment between • Many Irish exporters are small firms UK takes 43% of Irish UK and Ireland. • UK takes over 40% of Irish with no Treasury function so don’t indigenous firm exports , so indigenous firm exports , so very • Border with Northern Ireland will hedge currency exposure very important trading partner important trading partner become an external EU land border, • Cross border trade picks up as • Expected negative impact of Brexit with possible Customs checks. Look Expected negative impact of shoppers head North following to preserve Common Travel Area on UK economy will have knock-on Brexit on UK economy will have sterling's big fall effect on Irish exports to there • Ireland will lose key ally within EU knock-on effect in Ireland • Sterling weakness also has a • Agri, tourism, energy, retailing, when UK leaves as share similar views significant impact on cross-border on taxation, regulation, state financial sector most likely to be Sterling has fallen sharply on involvement in economy etc. businesses like hotels, restaurants impacted by Brexit Brexit concerns, which will hit exports to UK

Why Hedge? How long? How Much? Why? If a business generates revenues or cost in different currencies, it is exposed to Foreign Exchange (FX) risk whereby currency movements can affect the margin the business earns. To mitigate this many companies choose to hedge their FX exposures. FX hedging will: • Protect against adverse movements in FX rates. • Enable accurate forecasting and budgeting. • Provide a prudent approach where cash flows or margins are tight. How long and for how much? • What are the business/payment cycles? • What are the business margins ? • What line of sight exists for upcoming exposures? • How much rate certainty does the business require? • What is the market view and what is the business’s appetite for risk? • What is the business’s budget rate – how does this compare with prevailing market rates and trends?

Traditional methods of hedging FX exposures Natural hedging A natural hedge is the reduction in risk that can arise from a company’s normal operating procedures. A company with significant sales in one country holds a natural hedge on its currency risk if it also generates expenses in that currency. Having a currency account is imperative. For example, a company selling product into the UK is (partially) naturally hedged against the moves in EUR/GBP, if it can transfer some of their costs into GBP. For example: • Switch some of your product input costs to GBP • Ask for your distribution company to quote you a fixed GBP price* *Note, this doesn’t require moving to a UK supplier. As their costs will largely be in sterling, you may assist them in gaini ng natural hedging also.

Traditional methods for hedging FX exposures Spot Trades Spot Trade is an agreement to exchange currencies at a rate agreed today (the prevailing market rate) as your incoming/outgoing payments fall due. Main Features Customers who trade on the spot market are exposed to fluctuating currency markets between the invoice date and the actual payment date, therefore:  Underlying business margins are unprotected  Spot rates provide no cash flow certainty  Free to benefit from any subsequent favourable exchange rate moves.  No obligation to deal should your circumstances changes between the invoice date and the actual payment date  No credit limit required

Traditional methods of hedging FX exposures Forward Contracts A forward contract is an agreement to exchange currencies on an agreed date in the future (or during an agreed period) at a pre-agreed fixed exchange rate. Main Features • Cash flow certainty and underlying business margins protected against adverse exchange rate moves. • Unable to benefit from any improvement in FX rates, as you have committed to dealing at the agreed rate. • You are obligated to deal as per the agreed contract. If your circumstances change and you need to reverse out of that transaction you may be liable for a breakage cost. • Forward limit is required.

Traditional methods of hedging FX exposures Vanilla FX Option A Vanilla FX Option is like an insurance policy. In return for paying a premium, you buy the right, but not the obligation , to buy or sell one FX currency against another on an agreed future date, at an agreed rate (the strike rate). You decide the strike rate. There is no obligation on you to exercise your option. Therefore, if the spot rate on expiry is better than the strike rate, you can deal at the more preferable spot rate. This gives you unlimited potential to benefit from any favourable FX moves with 100% protection at the agreed strike rate. Example – Current Spot rate is 0.8450. You want the right but without the obligation to sell GBP £100,000 at worse case 0.8700 with a maturity date in 3 months time. In exchange you pay a premium of € 2,000. There are two possible outcomes on maturity: 1) The spot rate is lower than 0.8700, so you sell your GBP at the lower prevailing spot rate. 2) The spot rate is higher than 0.8700, so you exercise your right to sell GBP at 0.8700. Note: The premium is determined by the difference between the prevailing spot rate and the strike rate, and the time period hedged. The premium is non refundable, however it can carry a resale value.

Which Product is right for my company? Spot Rate Forward Contracts Vanilla FX Option Exchange rate No Yes Yes protection? Certainty of Rate? No Yes Known Worst Case Rate Able to participate in Yes No Yes beneficial rate moves? Upfront Premium No No Yes Payable? Potential Break Cost? No Yes No In most cases, some combination of the above is the most appropriate way to tailor a solution specific to your hedging requirements rather than choosing a single product.

Managing FX Volatility FX Market Orders FX Market Orders are used by businesses aiming to achieve a specific exchange rate in order to protect or maximize profitability on trade transactions. FX Market Orders come in 2 forms: Take Profit Order - You give an instruction to the bank to exchange a fixed amount of one currency for another currency should the market reach a specified exchange rate that is more favourable to you than the current market rate. Stop Loss Order - You give an instruction to the bank to exchange a fixed amount of one currency for another currency should the market reach a specified exchange rate that is less favourable to you than the current market rate. This limits the degree to which you are impacted in the event of an adverse move in the exchange rate. Note - Once the FX market order is filled, a spot deal or forward contract can be processed.

What next for Irish businesses? • Identify and understand your treasury requirements • Formulate a treasury policy which is suitable for your business • Set periodic currency budget levels • Develop an awareness of the markets and the risk mitigants • Be disciplined – most Irish companies use a combination of spot and forward FX • Engage with your bank/treasury provider