The loss of Theresa May’s majority in the House of Commons and the formation of a tenuous minority government shook the currency markets last week. The pound slumped, by 2.34% to $1.2635 against the dollar, echoing its tumble a year ago in the wake of the EU Referendum. And as the Tories and the Democratic Unionist Party (DUP) continue to wrangle the terms of their deal, and try to deliver Brexit, expect further ruction in the days and weeks to come.
And there’s a risk that some of these coming fluctuations might be man-made. Bouts of volatility make way for currency manipulation, as we saw earlier in the year when the Turkish lira’s turmoil was traced back to an alleged case of exchange rate tampering.
Companies that want to proactively manage their risk exposure to sterling following the election should take an early and serious look at the new Foreign Exchange (FX) code, in force since mid-May. The code is a revamped set of guidelines to encourage best practice across currency markets. Among other provisions, it comes with new requirements for risk management and strives to create greater market transparency.
It’s not a specific piece of legislation and the interbank market has no obligation to follow it, so It’s not yet known how the institutional FX market will react to it. However, corporates can’t afford to wait and see.
The combination of the currency volatility that could haunt a minority government and the new Code’s risk management principles mean corporates should hedge their sterling positions in the short-term. The plunge in the pound following the EU referendum last year has shown the vital importance of having weekly or even daily views of risk exposure, particularly in times of political uncertainty. And the new code’s risks management requirements make sound hedging decisions even more crucial for organisations.
