This article is provided by Alt21 Limited, trading as Alt21, an FCA authorised payments and FX provider and is intended for UK businesses considering FX hedging as part of their treasury activity. All examples provided are illustrative only and not a current or guaranteed rate. FX hedging can reduce uncertainty, but it involves costs, may limit the benefit of favourable rate movements, and is not right for every business. Please read the full disclaimer at the bottom of the page.
Currency hedging has a reputation problem.
For years, it’s been treated as something businesses graduate into as they grow, build out their finance teams and get more serious about FX.
But plenty of growing businesses are already hedging, using Forward Contracts to manage known future payments or a proportion of their exposure.
The problem is that we’ve made the next step feel like a bigger leap than it needs to be.
As exposures grow, forecasts change, or businesses look beyond forwards, hedging can suddenly feel like it requires a treasury department and an entirely new financial vocabulary.
It shouldn’t.
The products still need to be properly understood, and not every approach will suit every business. But there’s a difference between financial products having complexity and making the customer carry all of it.
Why SMEs put hedging in the too-hard pile
This isn’t a story about financial ignorance.
SME finance teams generally understand that exchange rates can affect supplier costs, overseas revenue and future contracts. You don’t need to be an FX expert to know the rate matters.
The problem is that hedging often sits in a particular purgatory – important, but not urgent.
When finance teams are stretched, and currency movements haven’t materially affected the business, reviewing FX exposure can easily become next quarter’s job. And then next quarter’s.
Complexity gives you another very convenient reason to leave it there.
It is recognised that for some businesses, leaving an exposure unhedged is a considered and reasonable choice, not an oversight.
Understanding currency hedging without the jargon
That does not mean the products themselves are risk-free, and each one should be assessed against your specific circumstances before use.
Forward Contracts. Mark-to-market valuations. Collateral requirements. Hedge ratios.
Put enough FX terminology into one conversation, and you can make a relatively straightforward business objective sound like something that requires a risk committee every Thursday.
The underlying question is usually much simpler:
Your business expects to exchange currency in the future. The exchange rate may change before that transaction happens. How much of that uncertainty does the business want to accept?
Hedging gives businesses different ways to manage that exposure.
That doesn’t mean you need to hedge every future payment. And it certainly doesn’t mean you need perfect knowledge of what your cash flows will look like six or twelve months from now.
Chris Canning, Alt21’s VP of Sales & Trading, sees that assumption regularly.
“There’s a perception that, to hedge, you need complete visibility on what your future cash flow is going to look like. That’s not always the case.”
I think we’ve set the bar unnecessarily high here.
Forecasts change. That’s what forecasts do. You don’t need to know exactly what every payment will look like six or twelve months from now before you can start thinking about the exposure.
Some businesses might hedge a proportion of an expected exposure. Others may build their hedge position gradually as forecasts become clearer, sometimes referred to as layered hedging.
Where the complexity for SMEs comes from
Many growing businesses already use Forward Contracts. The bigger barrier often appears when their needs evolve.
Tom Vooght, Alt21’s Head of Sales, sees this barrier appearing when those businesses start considering what comes after that.
“A lot of SMEs are already hedging a proportion of their exposure. I think it’s the next step of hedging, particularly options, that they think is too complex for them.”
This is where I think the industry has confused unfamiliarity with complexity.
FX Options carry different risks to Forward Contracts, including premium costs, and should only be used once those risks are properly understood.
But unfamiliar doesn’t automatically mean unsuitable, and requiring an explanation doesn’t make something an enterprise product. What matters is whether an approach fits the business’s cash flows, exposure and objectives.
The complexity can also be operational. Managing several hedges can mean calculating blended rates or valuing open Forward Contracts for accounting purposes.
As Chris puts it:
“A lot of people are reluctant to hedge because they don’t know how to account for it.”
Think about that for a second.
The thing stopping a business from considering a hedge isn’t necessarily the hedge. It might be what happens to it in the accounts on 31 December.
That’s not really an FX problem. It’s an operational one.
But tasks such as valuing open contracts don’t necessarily need to be calculated manually. That’s where technology becomes particularly useful because it helps reduce how much of that complexity the customer actually needs to deal with.
Currency hedging for SMEs isn’t about predicting the market
A hedge shouldn’t be judged solely against where the exchange rate eventually ends up.
If you agree to a Forward Contract today and the spot market later moves in your favour, the forward can look disappointing in hindsight. If the market moves the other way, it can look like a brilliant decision.
Neither tells you whether the original decision made sense for the business.
A good approach starts with understanding your exposure, having a reasonable view of future cash flows and deciding how much variability the business is prepared to accept.
That might involve Forward Contracts, FX Options, layering transactions over time or leaving part of an exposure unhedged. What fits depends on the business’s circumstances, cash flows and objectives.
For some businesses, putting those decisions into a clear FX policy can also help turn hedging from a series of individual calls into a more consistent approach.
The goal isn’t to predict where the market will be months from now. It’s to have enough information to make a considered decision today.
Hindsight will always give you the perfect FX strategy. Unfortunately, it arrives after you’ve had to make the decision.
There’s a human element to this too. Doing nothing can feel professionally easier because there’s no rate to defend afterwards. If you hedge and the market later moves in your favour, someone can point to the decision and ask why you made it. If you don’t hedge, the same market movement can simply look like something that happened.
That’s another reason hindsight is a poor way to judge a hedging decision. It’s also worth remembering that a hedge can mean paying more than the market rate at the time of settlement if rates move in your favour, which is the trade-off for reducing uncertainty.
The real opportunity is making hedging less intimidating for SMEs
I don’t think every SME needs a sophisticated hedging programme. And I certainly don’t think every business needs every FX product we can offer them.
I do think growing businesses deserve to understand their options.
Forward Contracts aren’t only relevant once you have a treasury department. FX Options shouldn’t become inaccessible simply because their mechanics require more explanation. And an imperfect forecast doesn’t mean you can’t start thinking about future currency exposure.
Complexity in finance isn’t always avoidable, but your customer shouldn’t be carrying the weight of it.
Technology helps reduce the operational burden, but you should still understand the mechanics and risks of any product before using it.
Then you can do the part that actually requires judgement – understand the exposure, consider the options and decide what fits the business.
We need to stop making SME finance teams feel like they have to be FX experts.
Explore currency hedging for SMEs with Alt21
Alt21 gives growing businesses access to FX hedging capabilities, including Forward Contracts and FX Options through one currency management platform.
Manage your currency independently through the platform, with access to FX expertise when you need it.
ALT 21 Limited is authorised and regulated by the Financial Conduct Authority (FRN: 783837) and is a company registered in England and Wales (number 10723112). The registered address is 45 Eagle Street, London WC1R 4FS, United Kingdom. This article has been produced by ALT 21 Limited for information purposes only. It does not constitute financial advice or an offer to sell or the solicitation of an offer to buy any products referenced. Hedging products are not suitable for every business. Before entering into any FX product, you should consider whether it is appropriate for your needs and circumstances. ALT 21 Limited assumes no liability for errors, inaccuracies or omissions. Eligibility criteria and terms and conditions apply to all products and services offered by ALT 21 Limited. Not all applications will be accepted.
About the author
Prit set the long-term vision and strategy of building the world’s leading alternative to a bank for mid-market businesses and high-net worth individuals. He has over 20 years’ experience in electronic trading, building digital hedging platforms, and experience fundraising through various stages of growth.
