Why Currency Risk Management Is Necessary for Your Domestic Business

Though U.S.-based companies that only buy and sell domestically in U.S. dollars may assume there is no need to manage currency risk, market movements may prove a more immediate concern than presumed.

After all, supply chain partners two or three links down may be exposed to foreign exchange volatility—and the costs of managing this exposure can become baked into the rates for a purely domestic organization.

Defining the risk

To illustrate, here’s a hypothetical situation: A Tennessee-based chemical company converts oil into plastics. The business purchases its oil domestically and also sells the plastics it has created domestically, buying and selling only in U.S. dollars. Superficially, there is no currency risk. Dig deeper, however, and you will find the company’s profits are strongly correlated with the euro—when the euro rises in strength, EU purchases of U.S. oil increase and the U.S. price of oil also increases. This could potentially lead to a fall in profits for the Tennessee company.

Another example: An Oregon retailer purchases stock from a US-based wholesaler rather than directly from manufacturers. The wholesaler manages his foreign exchange exposure from non-domestic suppliers by passing on costs to his customers—in this case the Oregon retailer.

This indirect exposure to currency risk can have a great impact on domestic firms striving to compete in a global marketplace—particularly with foreign firms that operate in the U.S. as part of their overall international structure.

As you can see, however obscured the connections to foreign markets, domestic U.S. companies do often have a level of currency risk to manage.

Be mindful of volatility

Events that impact the foreign exchange markets can drive currency risk for U.S.-based companies—and there is no shortage of such drivers today. A smart approach to managing currency risk is to first understand the underlying factors and how they may change the dynamics for your business.

For example, a number of U.S. trade agreements are currently being renegotiated—notably, the North American Free Trade Agreement (NAFTA) between the U.S., Canada and Mexico—which can lead to currency volatility.

In addition, the looming threat of trade wars and imposition of tariffs on certain exports and imports between the U.S. and countries such as China could have a profound effect on many domestic companies: While businesses operating in some industries may benefit from tariffs, others could see costs rise as a knock-on effect.

Domestic companies are not immune to foreign politics, either: The uncertainty around Brexit, for example, means both the UK pound and the euro could be increasingly volatile, which in turn would have an effect on the U.S. dollar.

It is important to remember that market movements can be a much more immediate concern for a supply chain partner which may be based partly abroad or be importing necessary materials. The cost of such a supplier managing its own foreign exchange volatility, as noted previously, can be passed on to your U.S.-based company.

Be proactive in managing currency risk

Once you have a sense of what might impact your bottom line, it’s time to take steps to hedge against market shift before you run into issues.

Bring in trusted partners to help identify the areas of your business that may be impacted and build a strategy—both immediate and long-term—to ameliorate any subsequent currency risk.

From creating a suitable hedging program to crafting a pricing list, seasoned financial partners can assist you in this quest in a variety of ways. Ultimately, these partnerships help provide the foundation and resources necessary to successfully negotiate the volatile market conditions and help build your business.

The views expressed by the author are not necessarily those of Fifth Third Bank and are solely the opinions of the author. This article is for informational purposes only. It does not constitute the rendering of legal, accounting, or other professional services by Fifth Third Bank, National Association or any of their subsidiaries or affiliates, and are provided without any warranty whatsoever. Deposit and credit products provided by Fifth Third Bank.