Why ‘Micro-Multinationals’ Should Worry About FX Risk

“May you live in interesting times,” runs an old proverb.

For those companies navigating the waves of FX volatility — which means a whole lot of companies, large and small, across verticals — these are interesting times indeed. In an interview with Karen Webster of PYMNTS, Karl Schamotta, who serves as chief market strategist at Cambridge Global Payments, said we’re living in a new age.

“Fluctuating foreign exchange rates are a relatively new phenomenon,” he told Webster. “It all goes back to 1973 roughly — that’s when the Bretton Woods agreement fell apart. No one yet has found a good way to price exchange rates or to price currencies. So we’re still in an experimental phase” when it comes to hedging risk or even anticipating it.  The volatility, he continued, “has become more important in recent years primarily because it is more material to the businesses that are involved.”

As Schamotta said, export and imports are far more important — and prevalent — today than they were five years ago, or a decade ago. Costs of goods or services used to produce — well, goods and services — are invoiced in foreign currencies. Increasingly, revenues are sourced in foreign currencies and are tied to the geopolitics and local business conditions of end markets.

In other words, more businesses are doing more business across borders. And as anyone listening to earnings calls might know, FX rates can make or break top lines or bottom lines. Think it’s a problem only for marquee global names for firms like Coca-Cola or IBM? Think again.

Micro Multinationals

“Even the smallest businesses today are putting their goods on Amazon,” Schamotta said, and shipping to customers all over the world. By definition they have FX exposure — “and by definition you have a situation where any type of volatility is going to have a bigger impact on the business itself,” he cautioned.

Welcome, then, to the age of the micro multinational. For those operating on a global stage, it helps to get a view of the stage itself, of the planks, as it were, that make up the stage in the first place. Writ large, there are three planks — namely the businesses, the financial markets and the economy — and as Schamotta stated, they all interact, and act on and with one another, continuously.

Setting the Stage for FX Volatility

Beyond the discussion of the businesses themselves as noted above, the executive said cross-border financial flows are higher than they’ve ever been. He said that “we now rotate about 1,410 trillion dollars a year through the foreign exchange markets a year, on the order of three or four trillion dollars a day. If you want to look at overall global GDP or global trade or any other measure, foreign exchange is about 14 to 15 times larger,” he said.

The money flows at hyper speed — effectively at the speed of light across the world, and Schamotta said it is moving, often, on the currents of shifting narratives tied to the financial landscape, as opposed to changes in fundamentals or changes in the day-to-day economies in which firms operate.

He echoed the sentiment of Shin Hyun-Song, economic adviser and head of research at the Bank of International Settlements. Picture the world as a series of interconnected balance sheets. A change in the balance sheet of the U.S. has an equal and offsetting effect somewhere else on the rest of the global economy. Conversely, a change in China impacts the U.S. balance sheet.

The ripple effect in an interconnected world is global and instant and … sometimes wrong. Thus another hallmark of FX volatility: sentiment masks or distorts or downright ignores fundamentals.

To get a sense of impact, consider the fact that economies can change about 2 to 3 percent a year, said Schamotta, but FX rates can move 10 to 20 percent over the same timeframe, and sometimes within a few hours. Brexit offers a telling example, where a 10 percent drop in sterling’s FX rate after the historic vote to leave the EU implied that the value of the entire country (based on its financial holdings) was down 10 percent.

Schamotta told Webster that there is a constant oscillation between fear and greed when it comes to FX, standing in stark contrast to the (usually) measured pace that marks interest rate movements telegraphed over months and years by central banks — or the relatively glacial pace of changes in consumer spending.

“FX changes happen overnight,” he said, “and while you were asleep … it’s happened already and is done.” Or to put it another way, “There is a misperception that FX rates follow fundamentals,” he told PYMNTS. “In the short run, markets react quickly amid shifts in perception … in the long run fundamentals re-assert themselves.”

Who’s in Charge?

But waiting for the fundamentals to reassert themselves over the long run is not effective corporate strategy. Against this backdrop, there are several levers companies — even micro multinationals — can pull in efforts to bring risk under proactive management.

For chief financial officers, the key is a dedicated approach, where there is a set of operating procedures, and where, as Schamotta termed it, “you follow them regardless of what is happening in the market … you take the emotion out of the equation, and you focus on the fundamentals that are affecting the business. This keeps you stable in the long run.” He said, too, that intelligence flowing to the CFO from the firm’s far-flung operations can help manage risk. It’s extremely important for people buying and people selling for the business on a global basis to be well aware of the foreign exchange implications and to communicate that information as quickly as possible to the financial executives of those organization, he told PYMNTS.

For global companies — from the biggest titans to the micro multinationals — according to Schamotta, “the risk that you’re facing at this point is that the flow of goods and the flow of money across the globe could actually slow or it can get interrupted.” Using the tools at hand — the computer programs and algorithms and predictive models — to try to forecast what will happen to FX rates is often a fruitless endeavor.

According to Schamotta, grappling with FX volatility is a strategic endeavor as opposed to a reactionary one. There is some use in automated market orders, in that “they sit there in the background and they work when you are asleep … they automate the smaller steps to mitigate the risk of a big move — again, the move that comes when you are asleep and not looking at the markets,” he said.

“You can’t eliminate all risk,” he told Webster. “You want to absorb a certain amount of risk. The key is to be able to harness that risk, to be able to put it within bounds and run the business in a pragmatic fashion.” Pragmatism, he said, means looking at the strategy that is in place and making only small modifications.

“Your overall strategy should not change all that often,” he said.