APEC Symposium – Taipei, August 2011 Enhancing SME Capacity of Managing the Risks Associated with Trade Liberalization APEC Symposium – Taipei, August 2011 Enhancing SME Capacity of Managing the Risks Associated with Trade Liberalization Workshop on Trade Liberalization and the Associated Risks Faced by Domestic SMEs John R. Rush Principal Consultant Oakbridge Limited

Relevant background  An advisor on foreign exchange risk management and expert witness in foreign exchange litigation  Almost 30 years presenting foreign exchange workshops internationally  Hundreds of workshops  Thousands of workshop attendees  Many workshop attendees part of a mix of SME exporters and importers across broad range of industries COPYRIGHT © OAKBRIDGE LIMITED 2011

Trade liberalization engenders risk  New commercial opportunities?  New markets?  New counterparties?  New risks – commercial and financial?  New currency exposures?  New regulatory environments? COPYRIGHT © OAKBRIDGE LIMITED 2011

Focus on management of exchange rate risk  In context of an SME managing its foreign exchange exposures, doing nothing is doing something  “Doing nothing” is tantamount to entering into, by default, the business of speculating on exchange rates  Speculating on exchange rates is a highly risky business  Contrary to popular mythology, banks really are risk averse entities and do not take large speculative foreign exchange positions COPYRIGHT © OAKBRIDGE LIMITED 2011

What often drives SME business decision-making when confronted by foreign exchange risk is…FUD COPYRIGHT © OAKBRIDGE LIMITED 2011

"FUD" stands for:  F  FEAR  U  UNCERTAINTY  D  DOUBT  But there is good news…  FUD can be dispelled and…  the effects of fluctuating exchange rates be mitigated, or perhaps eliminated COPYRIGHT © OAKBRIDGE LIMITED 2011

New trade opportunities bring new currency risks?  A strategically astute starting point for SMEs…  concentrate on core commercial business and…  do something about managing currency risks  If there is a desire to do so, currency risks may be totally eliminated  Effective commercial strategies are available  Range of financial instruments can be employed COPYRIGHT © OAKBRIDGE LIMITED 2011

Establishing a corporate foreign exchange risk management policy  SME owner/s or Directors should adopt and implement a foreign exchange risk management policy BEFORE venturing into new trade markets  Know how to cope, in principle, with a potential foreign exchange problem before it occurs  Within the policy document, provide for limits, controls and ongoing oversight so as to avoid costly financial mismanagement and/or fraud COPYRIGHT © OAKBRIDGE LIMITED 2011

Establishing a corporate foreign exchange risk management policy  Will the SME be a foreign exchange risk taker or be risk averse?  If taking a risk, how much risk? Quantify the level of risk.  Specify authorised instruments in which dealing is permitted (eg spot, forwards, options, futures, swaps)  Limits must be placed on all dealing – and a dealer breaking a limit should be dismissed! COPYRIGHT © OAKBRIDGE LIMITED 2011

Establishing a corporate foreign exchange risk management policy  Separate personnel performing dealing function from those confirming and settling deals  Policy should mandate a periodic “mark to market” revaluation exercise  Periodically review policy. If current policy not suitable for current trade and market conditions, change the policy COPYRIGHT © OAKBRIDGE LIMITED 2011

Commercial negotiations in new markets  An SME exposed to exchange rate risks could negotiate with its trade counterparty so as to…  Pay less for goods (if SME is an importer)  Charge higher prices (if SME is an exporter)  Invoice in home currency (if SME is an exporter) – and completely avoid dealing in foreign currency  All assuming the counterparty is in agreement at a “reasonable” price COPYRIGHT © OAKBRIDGE LIMITED 2011

The SME financial instruments tool kit  Spot foreign exchange contracts  Forward foreign exchange contracts (both deliverable and non-deliverable)  Borrowing and investing in foreign currencies  Foreign exchange derivatives (eg currency options, foreign exchange futures, short and long term swaps)  Cross rates (or “third currency” deals) COPYRIGHT © OAKBRIDGE LIMITED 2011

Technical financial understanding and independent advice  Understand all transactions  Must be technically competent personnel within SME who are not dealers – otherwise seek independent external advice  Be able to assess if the bank’s quoted price is “reasonable”  SME directors and senior executives should be competent to know “the right questions to ask” their in-house dealers and their bankers and…  …have sufficient competence to assess whether answers received reveal the whole truth COPYRIGHT © OAKBRIDGE LIMITED 2011

A note of caution for SMEs  Banks offering both “independent” transaction advice to SMEs and transaction pricing for the SME have an inherent conflict of interest  Banks generally not noted for the quality of the foreign exchange education provided to their SME clients COPYRIGHT © OAKBRIDGE LIMITED 2011

Know where the market is!  The more exchange rates fluctuate, the more important it is to have access to good quality, real time market rates  Many good Web sites now offer accurate real time foreign exchange market rates for free  Being out of touch with the markets may lead to costly missed opportunities  But don’t obsessively watch rates move. Take care of the core commercial business! COPYRIGHT © OAKBRIDGE LIMITED 2011

Summary  Foreign exchange risks can be controlled – but it requires: a desire to do so technical expertise ongoing oversight of risky positions  Adopt a professional approach to managing foreign exchange risks… cut losses quickly and let gains run - but have a “take profit” level in place  The price of solvency is eternal vigilance! COPYRIGHT © OAKBRIDGE LIMITED 2011

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